What I've been reading (vol. 11): Atkinson & Stiglitz

Atkinson, Anthony (2015) Inequality. What Can Be Done? Harvard University Press

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Atkinson, Anthony (2008) The Changing Distribution of Earnings in OECD Countries. Oxford University Press

The first two books, both written by the same author, Oxford economics professor Sir Tony Atkinson, will be reviewed jointly. The reason is that the earlier book, The Changing Distribution of Earnings in OECD Countries is more a case study summary of the empirical facts behind the rise of inequality in the West in the past century, the point of which is again summarized in the first few chapters of the author’s latest book Inequality. Basically the earlier book is a very detailed portrayal of the worrying inequality trend in the case of 20 OECD economies. It has two main parts – the first which depicts both the theoretical arguments and the summary of the historical trends for all the given countries, and the second which (on over 200 pages) details all the data, the graphs and the individual explanations of the causes of inequality for each of the 20 observed countries. The second book is a popular version of the same argument intended for “the masses”, but in particular aimed at the policymakers. After setting the diagnosis, describing the historical trends, and the economics behind inequality, the author dives into a very ambitious task of setting out a series of 15 concrete policy proposals that countries (but mostly the UK) can apply in order to reduce income and wealth inequality. The final part of the book then discusses the potential objections – are the proposals shrinking the pie, can they be done, will globalization hinder their effect, and finally will they be sustainable within the budgetary restrictions? 

Let’s start with the general conclusions of the first book in order to ease into the policy proposals of the second book. The first book is not intended for the average layman; it’s more an empirical economist’s companion on the vast data on inequality. The true gems of the book for the average researcher are precisely the 200 pages of data and graphs on inequality for each of the 20 countries. It’s a wonderful dataset above all (accessible here), and Atkinson goes to great lengths to describe all the faults and the benefits of the dataset, emphasizing on several occasions how the data is not comparable across countries (and to some extent it is even difficult to compare it within countries given the different methodologies for income reporting).

But before descending into the data he summarizes the trends. And they are in most cases bad. It is the story most people worried about inequality are by now quite familiar with. It has followed a trajectory of a decline after WWII which continued during the 50s, 60s and the 70s, but since the 80s it began to rise reaching its current unprecedented levels – well, at least that’s how the story goes for the US and the UK, Portugal, and the three transitional economies he has in the sample – Hungary, Czech Republic, and Poland, whereas the rest of Western Europe did not see such a high divergence between top and bottom income levels (the main comparison are the income levels of the top 10% vs the bottom 10% of income earners). After presenting these trends Atkinson delivers his own critique of the economic textbook model of inequality, in that technology and varying skills (attained through education) are not enough of an explanation. He adds to them an important role of the capital market (think of interest rates on student loans) but also explains in a bit more detail the so-called superstar model (people with extremely scarce skill for which there is a huge demand) and pay norms. 

In his more recent book, Inequality: What Can Be Done?, he does go a bit deeper into examining some of the causes of the rise in inequality. And he does it by first examining the factors that have lowered inequality in the post-WWII period, only to see most of them reversed in the 1980s making inequality rise again. One of biggest reasons in the post-war decline of inequality was the rise in the share of wages in total national income (reaching 80% of national income in the 1970s in the US and UK). In the subsequent decades the share of capital in income increased whereas the share of wages decreased. Furthermore the welfare state expanded significantly in the post-war era, as did redistributive social transfers. Unemployment was much lower, wage dispersion was reduced as the consequence of collective bargaining and government intervention in the labour market, while the concentration of capital income among the top income earners was in decline. Let’s also not forget the much higher income taxes on top incomes from that period. All of this basically went into reverse since the 1980s (on average higher unemployment, fall in share of wages and rise in share of capital in total income, declining power of unions, a cut in top income taxes and a scaling back of the welfare state). To this I would still add the forces of globalization (unskilled workers are mostly losers from trade) and technological change, as well as the effect of the capital market, changing pay norms and superstars (increasing demand for global talent). 

Although Atkinson here provides a very good overview of the facts, he gets carried away from time to time. For example, I didn’t buy into the argument that high income taxes in the period from 1950 to 1979 (when they averaged 75%!) were necessarily the reason why economic growth was high in the 50s and the 60s. The main reason as to why growth was high in those decades was probably the post-war reconstruction (the broken window hypothesis), plus the post-war baby boom which certainly encouraged greater consumption and hence significantly increased economic growth. When these two forces halted relative stagnation ensured in the 1970s. High taxes had absolutely nothing to do with growth at the time; if anything they could have contributed to the 1970s stagnation, since their relative decline in the 1980s did bring back growth. However, none of this has been empirically verified by anyone to my knowledge.

Let’s move to the proposals. They are exactly what one would imagine in a book like this – popular, to some extent utopist, very bold, to some extent controversial (the author even acknowledges this several times, but stresses that such bold proposals are necessary to make the public discourse move in the “right” direction). What disappoints me is that there is a lack of convincing evidence of the full effect some of these proposals will entail. There seems to be a focus only on one aspect of the story – reversing the factors that caused inequality to rise, without considering how this would affect other aspects of modern societies. Plus some of the ideas seem to me more like back of the envelope calculations than seriously thought-through proposals. Don’t get me wrong, I am in favor of reducing inequality, but a set of “concrete” proposals has to be more precise in how exactly would it affect inequality, and how exactly would it affect economic growth. There are three chapters in the back that are supposed to answer part of this (e.g. there is a simplified analysis of how some proposals would fit into the budget), but its not convincing. Other proposals don’t even qualify given that they are too vague. I understand this is a popular version and that the author clearly decided to avoid too much numbers and complexities not to bore the average reader. But to me, in order to even consider many of the proposals, I require much more details, first and foremost to give an answer how exactly the author thinks many of the proposals could be done (assuming even that they pass through the bi-partisan parliamentary process). Again, I fully understand his reluctance to go into greater detail, plus I understand he wanted to stir the dialogue, rather than to come up with a White Book of ready-made reforms. 

Having said all that, some of the proposals are actually quite good and even easy to implement. Like the capital endowment fund for children (minimum inheritance), the national savings bond to encourage savings, the child benefit to be extended to all children (and taxed as income for parents with higher incomes), the participation income proposal (similar to basic income, but different in terms of who has the right to get it, and how much), the earned income discount proposal, an interesting proposal for progressive lifetime capital recipient tax etc. However other proposals go directly against the empirical evidence the author himself cites. He does it on purpose (to create an effect of shock). E.g. he cites the paper by Brewer, Saez, and Shephard where they use a natural experiment setting to calculate the optimal top income tax rate (the one that would maximize revenue) at 40%. Atkinson however purposely calls for a top rate of 65%. Then there is the guaranteed public employment proposal (without at all calculating its effects), the code of practice for determining the living wage (to be determined by something closely resembling a central planning body), the proposal for property tax which disregards its potential effect on housing prices, etc. Overall, the proposals are certainly very interesting, however I would welcome a more detailed and more empirically justifiable argumentation for each of them.

Stiglitz, Joseph (2012) The Price of Inequality. WW Norton 

In what is essentially perceived to be a book about inequality, the Nobel-prize winner Joseph Stiglitz presents a very interesting portrayal of everything that went wrong in the US in the past few decades, in economic but also in political terms. Despite stable GDP growth, even in per capita terms, most citizens have not felt this growth and have actually witnessed their living standards decline. The US political system is failing as well; it is being captured by special interests which channel money towards the wealthy (via direct involvement in government redistribution but mostly via prone regulation and legislation), making America less and less a country of equal opportunity. In fact, the decline of social mobility, emphasized several times in the book, is an even bigger problem for the US. Both the poor and the rich are becoming entrenched in their positions in the income distribution, making it increasingly less likely for someone who is poor to climb the income ladder way to the top, and vice versa – it is very unlikely for someone who is rich to fall out of this category (educational opportunities play a key role here). All of this is without doubt true and very problematic as the US model of democracy is being shaken to its core. How can the US express its moral authority over others if it too has fallen into the trap of cronyism? Stiglitz however does not explicitly define all of the above as the consequence of cronyism or even interest group state capture; he likes to present it as a market failure, but also a political failure to deal with the market failure. 

For Stiglitz there is something broken in system; a system that seems to be designed to help those on the top at the expense of the rest of society. His main culprit here is politics, even if some of these forces are attributed to markets. The economic elites have used their money to buy political influence and hence political power in order to shape the system towards their benefit. This may sound a bit like conspiracy theory, but it has some merit. There are a multitude of examples of political capture by interest groups (via campaign contributions), but even more importantly regulatory capture (when an industry directly funds the politicians responsible for overseeing their practices), or even what Stiglitz defines as ‘cognitive capture’ – how only those who “agree” with the bankers are allow to write legislation and regulation that concerns the financial industry (this includes central bankers as well). 

An even bigger problem is how the wealthy (the top 1%) have acquired their wealth. Stiglitz attributes much of it to – rent seeking. An activity where one gets “income not as a reward for creating wealth but by grabbing a larger share of the wealth that would have otherwise have been produced without their effort.” And although this cannot be said of most of those in the 1% (I wrote about it a long time ago), it certainly does seem to be true for a considerable amount of those in the top. In the conference where I met Stiglitz, this was the main discussion, in fact – how many of those in the top around the world acquire their wealth through political connections (rent seeking) rather than via actual wealth creation. In other words the problem is that even though the pie is growing, a bigger and bigger amount of that pie is being captured by the rent seekers instead of the wealth generators. And that is indeed a huge problem. 

Another interesting part of the argument is the price we’re paying for inequality. Stiglitz goes beyond the trade-off between equality and efficiency stating that too much inequality is also bad for efficiency and bad for growth. He’s right, and it’s easy to see how – for one thing, having too many people left out of the benefits of economic growth derails their consumer spending power. I too have long considered the relationship between equality and efficiency to be non-linear, instead of just a simple trade-off. Too much equality isn’t good since it reduces incentives, but neither is too much inequality. I would say the relationship is of an inverted-U type where moving to both extremes – too much and too little equality is bad for the economy. The trick is to find an optimal point which reduces the level of inequality where it offers more opportunities for everyone, but also just enough for it to continue to drive incentives. More on that in my next blog post. 

Having said all this, there is still a feeling that the book lacks clarity in certain parts, as even within chapters it tends to jump from one argument to another. It gives the impression that it was either written too fast, that it was assembled quickly using some old writings, or even that certain chapters were written by someone else (several times he uses the “I” form, but in a few chapters there is also the “we” form, as in “our argument is…”). 

Plus there is often incoherency in the arguments. In the early chapters he claims that markets are not the principal driving force of the current status of the US, since all other countries are operating on the same market principals. His hypothesis is that the market forces are real but are being shaped by the political process that defines laws, regulations and institutions, all of which has some distribute consequences. Then in the closing few chapters he resorts to his usual bashing of the market forces and a cry for an omnipotent government to solve their failures. The biggest problem with this standard argument from the Left is that they expect the very same corrupt politicians, enslaved by their clientelistic relationship with powerful interest groups, be given even more power to supposedly fix the system. That’s why, in essence, redistribution is not the answer – given the issue of who is making the distributional decision. The answer is to change incentives (or “ideally” to elect someone like Stiglitz to lead us, right?). 

And then we come to the policy proposals; his grand economic reform agenda followed by a rather disappointing political reform agenda (disappointing given his excellent recognition of all the errors of the political system). Each is to be applied simultaneously in order to, well, create a better world, what else?! Reading these agendas (summarized on about 20 pages in the final chapter of the book) felt like reading a political program for a generic social-democratic candidate for president/prime minister. It was just a bunch of bullet points whose only purpose is to convey a positive message to the voters, rather than being a set of policies that can actually fix the system. Particularly when comparing them to Atkinson’s proposals, with whose details I also wasn’t really satisfied, but at least Atkinson made some effort into discussing the viability and applicability of each proposal. With Stiglitz, it all sounds just too cheap. For most of the proposals there isn’t a single sentence in how they are to be implemented, not to mention what the potential effects could be. Apart from the usual – if we implement all this we’re going to have a better society! It really is a mediocre political program. 

Now don’t get me wrong, some of the things he proposes in the book are quite good. I particularly agree with his criticism of “GDP fetishism”, given that GDP does not accurately reflect living standards, and particularly the sustainability of the economic growth model. Or the ideas to end corporate welfare (like hidden subsidies to big corporations and government giveaways in the form of procurement), to improve access to education, help Americans save (there is btw no indication as to how this is supposed to be done, but OK), expanding health insurance, improving the legal system, curb discrimination, etc. However others are just too much, or can be completely incoherent (like all of his proposals to curb the power of the financial sector – there is no indication as to how this was supposed to be done). Some are just breathtakingly shocking. For example I was bemused that a self-respecting economist can utter these words: “If exports create jobs, then imports destroy jobs; and we’ve been destroying more jobs than we’ve been creating” (pg. 279). Wow! A Nobel-prize winning economist succumbing to the most basic mercantilist fallacy by saying that imports destroy jobs is just unbelievable. You’re not running for President, Prof. Stiglitz, please do away with the conspiracies.  

However, I would still recommend the book even to those who usually disagree with Stiglitz, because if you can look past some of his standard ramblings, he really does deliver a decent analysis of some of the things that went wrong with the US political system.