Distributional Politics of the Ice Cream Parable

Tyler Cowen is thinking out loud:

This parable assumes that [monetary] injection effects are important, namely where the new money goes first. This Austrian-like view is unfashionable, has weak theoretical foundations, and violates the Modigliani-Miller theorem, but at the moment markets seem to believe it. Should we believe it too?

Yes we should. Or at least we shouldn't let Modigliani-Miller stop us. In his 2011 Presidential Address to the American Finance Association, John Cochrane said the following:

Discount rates vary a lot more than we thought. Most of the puzzles and anomalies that we face amount to discount-rate variation we do not understand. Our theoretical controversies are about how discount rates are formed. We need to recognize and incorporate discount-rate variation in applied procedures.

If discount rates are varying a lot -- across time, space, and actors -- then a representative agent model such as Modigliani-Miller is not going to perform very well. And, as it turns out, it doesn't. I have paper, while I'll be sending out for review soon, which drills down at banks' activities (at the firm level) across countries and time. It turns out that there is all kinds of variation being driven by a whole host of variables at multiple levels of analysis. Which, you know, we all know intuitively... but it's not what our models expect. So let's ditch Modigliani-Miller. Capital structure is clearly not irrelevant in the real world.

Going back to Cowen, here's something with which we might be concerned. Central banks act by trading debt instruments for others at price. In normal times the swap is either short-term sovereign debt for cash or present dollars for future dollars plus interest. In our current environment, it's practically anything for cash. Who benefits from this situation? Those who can create debt that can be sold to the central bank for cash. In normal times this has primarily been governments, but governments are doing everything they can to stop creating debt. So who does that leave? Banks.

Because central banks want to be active they have been broadening the range of debt instruments that they will conduct business in. So here's a worrisome dynamic: governments are trying to reduce debt, while banks are being encouraged by central banks to create debt instruments which they can trade for cash. Karl Whelan may be correct that traditional solvency concerns don't apply to central banks, but that doesn't mean that there aren't knock-on effects from this.

The upshot is that expansionist central bank policy requires somebody to lever up. If governments won't do it and households can't do it then banks and large corporations pretty much have to. The more activist the central bank wants to be and the less indebted the government wants to be, the more banks have to create debt instruments however they can. Possibly that could mean loans to individuals and smaller firms, which could be stimulative, but households and firms are deleveraging. Meanwhile, bank regulators are telling banks to stop lending to risky groups. So where's the debt going to come from?

Banks and big credit-worthy firms are going to do very well. They're getting debt finance for free, so their equity can be deployed elsewhere or held in reserve. This is why stock markets are up so much. This is why Apple and other corporations are taking out loans when they don't even need the cash and have no real plans to do much of anything with it in the short run. Everyone else is not going to do very well, because the traditional mechanisms for distributing from central banks to the citizenry -- fiscal policy plus bank loans to individuals and small firms -- is being cut out of the story. In one sense that might be okay if the future costs of debt servicing are higher than the expected return folks would get from borrowing. But the distributional implications of this are clear: the economy is going to become more unequal and less efficient. Credit is not being allocated to facilitate productive investment -- there might not be many -- but to create debt instruments to sell to central banks for cash. The policy mix we have right now practically requires inequality to go up, which is a sign that the economy is seriously imbalanced.

One alternative is to let risk back into the system but I don't hear anybody calling for that right now.

At some point central banks will be pressured to tighten. It looks very likely that this will be under conditions of steady but slowish growth. This is where the Big Unknown comes in. When that day comes will banks (and corporations) start using their cash productively or keep hoarding it? Given the experience of the past decade or so, will there be many people who even want to borrow in order to build a McMansion or buy a luxury car or MBA? If they did, will regulators let banks lend to them? Will the originate-securities-and-distribute-to-surplus-countries market come back as strong as before?

On Keynes, Marx, Krugman, Cowen, and the Possibility of Utopia Via Inequality

At the end of a good post on the shift of income shares earned by capital (more) and labor (less) in the US over the past few decades, Krugman writes:

I think we’d better start paying attention to those implications.

What implications?

[I]t makes nonsense of just about all the conventional wisdom on reducing inequality. Better education won’t do much to reduce inequality if the big rewards simply go to those with the most assets. Creating an “opportunity society”, or whatever it is the likes of Paul Ryan etc. are selling this week, won’t do much if the most important asset you can have in life is, well, lots of assets inherited from your parents. And so on.  

I think our eyes have been averted from the capital/labor dimension of inequality, for several reasons. It didn’t seem crucial back in the 1990s, and not enough people (me included!) have looked up to notice that things have changed. It has echoes of old-fashioned Marxism — which shouldn’t be a reason to ignore facts, but too often is. And it has really uncomfortable implications.

As it happens, I've been writing about this for quite some time. It was the focal point of my criticism of Tyler Cowen's "Great Stagnation" hypothesis (e.g. 1, 2, 3, and others), which I said was a "Great Redistribution". Basically the question I'd like to answer is why mean and median incomes have diverged, as pictured in the graph above. A "Great Stagnation" hypothesis seeks only to explain the flattening of median income growth. But we haven't had a Great Stagnation, since mean income growth has continued, at least until the Great Recession.

A Great Redistribution view, on the other hand, says that the structure of the global economy has changed over the past 40 years in ways that benefit (US) capital and hurt most of (US) labor. Specifically, the rise of a low-skill labor force in the former global South has competed away wage gains from low-skill American workers, while the rise of a medium-skill industrialized labor force in places like the NICs has competed away wage gains from medium-skill American workers. Additionally, the rise of mechanized labor (via robotics, which prompted Krugman's post) shifts income from labor to capital. Take a look at this chart:

Wages are converging globally, and since the US had disproportionately high wages this is hurting American labor in relative terms. At the same time, the global market has expanded dramatically. This increases the return to high-skill American labor as well as the owners of capital, who can now sell their production to much larger markets. This is particularly the case for goods and services which are reproducible at essentially zero marginal cost: think intellectual property and entertainment. Since the "high skill labor" and "owners of capital" groups are not mutually exclusive, this shows up in the data as both a) increasing wage inequality, and b) increasing returns to capital.

This is the simplest story in the world... basically just stating comparative advantage, at a mix of sectoral and factoral levels. The fact that it's so novel -- even to someone with a Nobel Prize in international macroeconomics! -- is a point of evidence that our intellectual class is way too focused on explaining everything locally. The Great Redistribution view has plenty of implications for political economy at global and local levels, but it is essentially a rejection of many public choice arguments, which tend to emphasize capture of political institutions by bankers or other oligarchs as the fundamental driving force in recent trends in the American economy.

I'm not sure what Krugman means by "uncomfortable implications". It could mean that the fact that the economy is working the way the way it's supposed to is an inconvenient truth for those who think that our political economy is being wrecked by those who prefer public choice explanations. But I doubt Krugman means that. It could mean that the "Golden Age" of American labor that Krugman loves so much -- the 1950s-1960s -- was a historical anomaly, the result of specific contingent circumstances that are not likely to be replicated ever again (and would be tragic if they were, given that that arose because of two devastating world wars and a Great Depression). But I doubt Krugman means that either. It could mean that the technocratic neoliberal vision is a fraud, and that the politics of distribution is likely to dominate capitalist political economies for the foreseeable future.

In any case, as an example of this Krugman talks about "re-shoring", the process of bringing manufacturing production back to the United States. Krugman suggests that this will have no major effect on employment or the income accruing to labor, because much of this production is done using robots. I think he's right that the direct effects on labor and wages will not be much. The indirect effect could be much higher, however. Why? Because in order to have robots build things, you first have to have factories. Humans have to build those. And you have to have roads to transport the goods. Humans have to build those too. And you have to have shops where the goods can be sold. Humans have to work in those shops. The desire for human labor that is complementary to robot labor can support wage gains for the median worker. That may not be enough to overwhelm the relative redistribution from the median worker to the top 10%, but it can help the absolute numbers.

American labor can benefit in another way: by receiving more non-cash compensation. The trend in the US is to provide more years of subsidized non-work at the beginning and end of life -- longer periods of education, longer retirements as lifespans increase -- and more non-cash benefits -- subsidized health care and education -- in a somewhat egalitarian way. These programs are overwhelmingly funded by the top 10% of wage earners, who are the high-skilled workers and the owners of capital*. To the extent that goods are increasingly created by non-human labor they free up people to do other things, some of which will not be market work. We'll call that "unemployment" or "underemployment" but if we generate sufficient national income to guarantee minimum standards of living at a level that ensures human dignity it will function as quasi-early retirement.

At the same time, quality of life continues to increase rapidly as the marginal cost of entertainment, education, and other goods approaches zero as a result of advances in information technology. This gain is felt by the median member of society as much as the richest person in society, and is more valuable for those with more available time. In terms of maximizing valuable leisure and minimizing alienating labor the typical citizen might be doing better, maybe even much better, than she otherwise would even while the data continue to show that she is doing much worse.

If this is an equilibrium it will have some negative consequences, for sure. Among them will be a reduction in social mobility and an increasingly bitter political economy. But Keynes dreamed of a world in which the gains from capitalism were distributed in a way that allowed people to work less, and some people are still dreaming of it. Marx too: his criticism of capitalism was not just that it generated inequality, but that it created alienation as labor became routinized. Marx didn't care about social mobility... he cared about human dignity. So maybe the left should welcome our new robot overlords (and their capitalist owners) for bringing the vision of Keynes and Marx closer to reality. Instead of slaving away in factories we can all post kittens to Tumblr and write stimulating blog posts. Yeah, maybe it looks like inequality, but it could end up being Utopia.

*The US tax code is already pretty progressive, and is likely to get much more progressive over the coming years, beginning with whatever deal comes out of the fiscal cliff negotiations. At the same time, the US benefit system is one of the least progressive, but I expect this to change over the coming decades for political economy reasons. Ultimately it will be up to the democratic system to manage these structural shifts.

Who, Exactly, Is Getting Away With What, Exactly? And Why?

In an recent article in the NY Review of Books, Paul Krugman and Robin Wells review three recent books that attempt to diagnose just how American political economy got so screwed up after 2008*. Noam Scheiber blames Obama's choices of economic advisors, and in particular the reliance on acolytes of the Rubin-Summers faction of Clinton administration vets who have a predilection towards getting into bed with Wall Street. Next comes Thomas Frank, demonstrating yet again that he understands nothing about American politics or political history (and in particular the politics and political history of the American right wing). Frank claims to have observed "something unique in the history of American social movements: a mass conversion to free-market theory as a response to hard times" that is buttressed by hermitically-sealed stupidity. If this is indeed a first then what exactly was "morning in America" all about? And how to explain the rise of right-wing parties throughout the industrialized (and industrializing) world since 2008, much less the landslide victory of Obama in the 2008 election? Thomas Edsal's thesis -- which Krugman and Wells reject as incorrect on its face -- is that America does not have enough resources to accommodate conflicting social goals, which has led to in uptick in partisanship.

So we have three theories: Scheiber's leadership failure cum rent-capture critique, Frank's vast right-wing conspiracy cum ignorance critique, and Edsall's scarcity leads to nasty politics critique. While showing signs of sympathy for all three, particularly the first two, Krugman and Wells end up with their own conclusion:

But ultimately the deep problem isn’t about personalities or individual leadership, it’s about the nation as a whole. Something has gone very wrong with America, not just its economy, but its ability to function as a democratic nation. And it’s hard to see when or how that wrongness will get fixed.

Let's leave (mostly) aside that this political narrative is opposite in emphasis of the tale Krugman was telling a year ago (cf) -- then it was about personalities and leadership -- and note the defeated tone. While some of Krugman's friends believe that the only way the wrongness will get fixed is through the destruction of the Republican Party (eg), that isn't going to happen so there must be some other way out of the malaise. The problem is that Krugman and Wells seem to have few answers on that score. I believe that is because they don't have a clear conception of politics.

Each of these three concluding sentences contains a distinct phrase of dissatisfaction. The first asserts that there is a "deep problem" in American politics; the second identifies that problem as the lack of an "ability to function"; the third summarizes these first two components as culminating in "wrongness". These are vague, even non-descript, but let's try to parse each of them.

Given the context of this essay within their other writings, the "deep problem" would seem to be persistently high unemployment and growing inequality. How do I know that Krugman and Wells think this is the problem? Mostly from the context of their other writings, but in this essay the refer to parallels between today and the 1930s, a period of high unemployment that followed a rise in inequality and significant financial crisis. The cause of these problems would seemingly be both ideational -- capture of elites in government (Congress, the Fed) and the commentariat, as well as much of the public, by right-wing laissez-faire orthodoxy -- and material -- capture of the government  (the Obama administration, the Fed) by Wall Street. Both of these phenomena have been discussed in the political economy literature, of which Krugman and Wells are completely unfamiliar**.  

The next sentence indicates that this problem is not limited to economic outcomes: there is also a political problem, the "(in)ability to function as a democratic nation". It is not at all clear what he means by this. I think he means that democratic nations are supposed to always and everywhere and at all times generate egalitarian outcomes, and pursue policies that maximize some deduced social welfare function that just so happens to map onto Krugman's ideological preferences more or less perfectly. Other than vague intimations that bankers control the country through their puppets in the Obama administration, it's not clear why Krugman thinks that the U.S. doesn't function as a democracy. Because it hasn't generated a particular set of outcomes in a given time and place? What a priori reason do we have to think that this should happen? Why should we think that the U.S.'s version of democracy is somehow superior to other democracies that have similarly depressed economies, e.g. Europe?

The fact is that "democracy" is a catch-all word that describes a host of political institutions which are similar only in that they aggregate the preferences of their citizens through some type of electoral process which is guided (and constrained) by previously established law. "Democracy" is decidedly not
a description of a set of particular outcomes favored by the technocratic center-left, a group of which Krugman is a member. It is even less a description of a political system dedicated to pursuing an Old Keynesian version of technocracy. Given that, it is not completely clear to me that the U.S. has lost its ability to function; conflicting interests, partisanship, gamesmanship, interest group lobbying, rent capture, and vituperative campaigns are all par for this course, not evidence that things have gone horribly awry.

Which leads us to the very end. This "wrongness" -- essentially the existence of distributive interest group politics -- is only a "wrongness" if you expect particular (and exceptional) moments of national unity (such as the bipartisan passage of the Social Security Act that Krugman and Wells reference at the top of the piece) to be the norm. But they are not the norm, and we should not expect them to be. Democratic politics is generally messy, generally contentious, and generally fought along lines demarcated by interests and ideology. Any particular individual -- and in fact all particular individuals -- will be upset with roughly 50% of the political decisions made. This is just how it works. There is no sense in bemoaning this, as it is a fact of life. It is not a "coup", it is not a systemic collapse of everything we hold dear.

It's not clear to me why the NY Review of Books would ask non-political economists to write about political economy. Had they not they not done so, they might have been able to publish an article with a better ending then "We don't like this but we don't know how to fix it."

*By "screwed up" the authors seem to all mean something along the lines of "President Obama only getting to fulfill most of his campaign promises". These being provision of universal health care, no tax increases on those making under $250k/year, an aggressively militaristic anti-terrorism policy, re-regulation of the financial sector at both the domestic and international levels, the repeal of DADT, and increased investment in green technologies. Or by "screwed up" maybe they mean the continuing existence of an opposition party, or the fact that Obama was always insufficiently left. Anyway, Krugman and Wells just take it for granted that something is screwed up, and the impression they leave of the books they review is that the other authors do the same thing. I haven't read any of those books so I can't be sure whether that's a fair characterization or not.


**I can be quite sure of this, having read them both extensively over the years. The closest thing to a political economist to whom Krugman gives credence is Larry Bartels, an American politics scholar who has studied some politics of inequality.  

Am I Reading This Wrong?

Krugman reproduces the above graph and writes:

[T]his recent survey paper (pdf) on teen births, which are much higher in America than in other advanced countries. The authors find evidence suggesting that inequality and lack of mobility are central, another sign that Wilkinson-type views about the corrosive effects of inequality are going seriously mainstream. ... [I]nteresting stuff — and more evidence that we are gradually poisoning our society with inequity. 

I've only skimmed the paper -- which was published in the Journal of Economic Perspectives -- but I don't read it the same way at all, nor do I see it from that graph. What I see is that the discrepancy is mostly driven by whether the mother is well-educated or not. As far as I know whether or not students graduate from high school is not a function of inequality, but of poverty and other socioeconomic and cultural factors. Indeed, that is what the authors of the report conclude:

We believe that the high rate of teen childbearing in the United States matters because it is a marker of a social problem, rather than the underlying social problem itself. If a teenager has a baby because her life chances seem so limited that her life will not be any better if she delays childbearing, then teen childbearing is unlikely to be causing much of a detrimental effect. Our review of the evidence is consistent with this position.

At times the authors seem to think that poverty, social mobility, and income inequality are the same thing. I would be more likely to attribute all of them to common underlying causes that has been transforming the global political economy over the past 20+ years. In any case, the authors argue that improving economic opportunities is the way to improve this statistic. In fact, they explicitly rule out increased income inequality as playing a causal role in recent trends, noting that teen childbearing has been going down over the past generation (implying a negative correlation with income inequality if there's any relationship at all):

One thing that we have not done is explain the dramatic decline in teen childbearing in the United States over the past 20 years. Although we believe that inequality and lack of opportunity explains a substantial share of the geographic variation in teen childbearing, it is not a candidate explanation for the downward trend in the United States over the past two decades, primarily because the 50/10 ratio that we rely on as a measure of inequality has not changed much during this period (although our results are insensitive to the specific measure used).

So what on earth did Krugman read? If teen childbearing has been going down at the same time that inequality has been going up that would seem like prima facie evidence that income inequality is not causing teen childbearing.

Facts on US Inequality

I like this post by Derek Thompson on inequality in the US. It's not polemical, instead presenting important facts in the easy-to-understand graphs and charts. Most of it I knew previously, but not this:

When you add it all up, we have a country with steep divisions between rich and poor and a tax code that for all of its problems is progressive (although it has been more progressive in recent year). Here are two more graphs to take you home: the first shows share of income by quintile and the second shows share of federal income taxes by quintile. What you'll see is that income inequality is behind tax burden inequality.

The whole post is worth reading, and the accompanying graphs are enlightening.

The Great Crash 2008, Part One

In "Cause and Consequences", the last chapter of The Great Crash 1929, JK Galbraith offers his explanation for why the Great Depression rather than a typical recession followed the stock market collapse. Or, as he put it, why the economy was "fundamentally unsound" in the run-up to the stock market crash that led to a prolonged slump. There are five reasons given (beginning on pg. 177 of the 2009 Mariner paperback, for those wishing to follow at home), and it's worth thinking about each to see how they may or may not relate to today. I'm going to do them in a series for the sake of brevity. This is the first.

Galbraith's first reason given for why the stock market collapse plunged the real economy into deep depression is the large amount of income inequality. Galbraith writes:

This highly unequal income distribution meant that the economy was dependent on a high level of investment or a high level of luxury consumer spending or both. The rich cannot buy great quantities of bread. ... Both investment and luxury spending are subject, inevitably, to more erratic influences and to wider fluctuations that the bread and rent outlays of the $25-a-week workman. This high-bracket spending and investment was especially susceptible, one may assume, to the crushing news from the stock market in October of 1929.

It's well-established that US income inequality increased dramatically over the two decades prior to the 2008 crash. Here's a snapshot of the share of national income going to the top 10% of income earners from the famous Piketty/Saez historical study of the American income distribution (labelled and discussed by Krugman here)



The graph ends a few years before 2008 but the trend didn't reverse in that time. What I like about Galbraith's explanation of the role of income inequality in the Great Depression is that there is a plausible causal story: with increased inequality the economy becomes more dependent on the fortunes of the high-bracket folks to maintain demand and investment; a shock to their finances via a financial crash thus hurts more than it otherwise would. This can link up with demand-side and structural explanations of the sclerotic US recovery. Too often discussions of contemporary income inequality lacks such a mechanism, and are much more normatively framed and politically charged. That's fine, but it doesn't really help us understand how income distribution affects the broader economy.

The question is whether Gailbaith's causal story matches the present. Let's look at some data on private investment. We know that there was a slump in housing, so let's check that first:




It drops off a cliff, but notice that that begins in late-2005. This is in line with the usual story that the housing collapse preceded and perhaps caused the financial collapse by deteriorating the value of the underlying assets on which securities were backed. For Galbraith's story to be true, we'd need to see investment drop off after the financial collapse destroyed the wealth of those at the top of the income distribution. And we do:



Note that in percentage terms, the dropoff post-2008 is more severe than what occurred during the 2001 recession. My back of the envelope estimate is that investment at the trough post-2001 was ~ 88% of the pre-2001 peak; In 2008 it was 78%. Moreover, investment fell more steeply more quickly post-2008 than post-2001. But it also rebounded in a sharper V-pattern than in 2001. If Galbraith's logic held, we might expect to see the opposite: a deeper, longer investment drought. Sometime like an 'L'- or 'U'-shaped pattern of recovery.

Let's look at some consumption data:



Here we see a much bigger dropoff post-2008 than post-2001, and it persists for much longer. While we've gotten back to pre-2008 levels, we haven't yet caught back up to trend. But is this slack enough to explain the persistent malaise in labor and financial markets? And is the slack in spending and investment attributable to income inequality rather than high unemployment? Is high unemployment attributable to income inequality? There's no obvious mechanism that explains it. At least not that I can think of.

It may be that increased inequality was a symptom of structural shifts in the global economy that pre-dated the crash. An effect rather than a cause. Post-crash inequality becomes a cause of ongoing economic weakness. However as a first explanation for the Lesser Depression I'd look elsewhere.

In any case, the major political battles in the US since the financial crisis have been on issues related to income distribution: health care, financial regulation, and progressive taxation vs. expenditure austerity. Maybe we could add classic Phillips-curve battles over unemployment/inflation tradeoffs.* This suggests that the cleavages in the economy break down along at least some of these lines. But this could be a consequence of the weak economy rather than a cause of it, especially since the political scene has shifted from fire-fighting to deficit-cutting.

*Krugman and others argue that right now there isn't much of a tradeoff and I tend to agree, but neither the political leadership of the GOP nor most pundits seem to believe him.

Inequality and Fiscal Deficits

A newish paper from Martin Larch at the European Commission's research office:

Fiscal performance and income inequality: Are unequal societies more deficit-prone? Some cross-country evidence

A bias towards running deficits is an entrenched feature of fiscal policy making in most developed economies.

Our paper examines whether this tendency is in any way associated with the personal distribution of income of a country. It takes inspiration from theoretical work according to which distributional conflicts may give rise to deficit spending or to delayed fiscal adjustment. Although these theories have been around for years the empirical literature on the determinants of fiscal performance has so far paid little or no attention to the possible role played by different degrees of income inequality.

Our results suggest that this neglect was not justified. Using cross-country data we find evidence that a more unequal distribution of income can weigh on a country's fiscal performance. These findings can be relevant in the aftermath of the post-2007 global financial and economic crisis in particular when designing fiscal exist strategies. The success and sustainability of such strategies may inter alia depend on their distributional implications.

Social Science Journalism

The lesson of history is that, in the long run, super-elites have two ways to survive: by suppressing dissent or by sharing their wealth. It is obvious which of these would be the better outcome for America, and the world. Let us hope the plutocrats aren’t already too isolated to recognize this.

That is Chrystia Freeland in The Atlantic, summarizing Daron Acemoglu and James Robinson's Economic Origins of Dictatorship and Democracy without realizing it. The whole article is very good.

A Schumpeterian Take on Our Macroeconomy

What is the likelihood that this from Tyler Cowen and Jayme Lemke is true:

In essence, we have seen the rise of a large class of "zero marginal product workers," to coin a term. Their productivity may not be literally zero, but it is lower than the cost of training, employing, and insuring them. That is why labor is hurting but capital is doing fine; dumping these employees is tough for the workers themselves -- and arguably bad for society at large -- but it simply doesn't damage profits much. It's a cold, hard reality, and one that we will have to deal with, one way or another. ...

In other words, the U.S. economy is going through some major structural shifts. It's not a question of getting back to where we were, but rather that the economy must solve a new problem of re-employing a lot of people who were not, in reality, producing very much in the first place. That's a steeper challenge than we had realized early in the stages of this recession -- and so far policymakers have failed at meeting it.

It's impossible to know for sure of course, but I'd put the number at at least 50%. Note that this is a Schumpeterian view of this recession, much maligned by Keynesians but that contains an internal logic, in which a period of "purging" and reorganization of the economy is required for full recovery*. If true, it begs questions: do all recessions have similar underlying causes? If not, is there a standard policy playbook that can be applied at all times?

I don't agree with the title and one of the conclusions: 10% unemployment is unlikely to be the new normal. Even the liquidationists and Schumpeterians thought that once the purging was over the economy would adjust. Maybe that takes 5 years or 10, but in the grand scheme of things that's not forever.

In terms of politics, it seems clear to me that the U.S. is being fragmented in many more ways than just divergences in income. Capital has recovered from the recession, and business income and profits are now very high. Skilled labor never suffered all that much (in terms of employment, if not loss of financial wealth), and the unemployment rate for those with college degrees is now below 5%. For those with postgraduate degrees it's under 3%. Almost the entire brunt of the recession has been felt by those with less education and fewer skills. It's not just income inequality -- as The Economist noted in a much-discussed recent article, PhDs often don't make a lot of money -- but also inequality of job stability or perhaps mobility.

What does this sum up to, politically? It leads me to think that college education should be much more accessible (at lower cost) than it currently is. This could include vocational schools, but we should encourage broader educations more. In primary and secondary schools we should definitely emphasize teaching skills that are broadly applicable, like mathematics, rather than just teaching facts and knowledge. It makes me think that we should reduce or eliminate programs that encourage home ownership for everyone, including the mortgage interest deduction, and promote mobility in other ways**. We should definitely cut payroll taxes (as the recent tax compromise finally does), or even better eliminate them entirely. Replace them with a VAT or higher marginal income rates if necessary.

I'm sure the Keynesians will rebut this over the coming days, but right now the recession only exists for less-skilled labor, not for capital or high-skilled labor. It's been that way for some time. If that's not a structural recession than I'm not sure what would be.

*Schumpeter put it thus: "Depressions are not simply evils, which we might attempt to suppress, but forms of something which has to be done, namely, adjustment to change."

**Krugman and others say that structural factors are not important because there is not a deficit of labor in any sectors, while there is a surplus in most. But structure could be about location rather than just industry. Clearly too many people live in Detroit. Probably too few live in Bismark.

UPDATE: Finally getting around to reading Chrystia Freeland's profile of the nouveau riche in The Atlantic, and it opens with this from Alan Greenspan:

IF YOU HAPPENED to be watching NBC on the first Sunday morning in August last summer, you would have seen something curious. There, on the set of Meet the Press, the host, David Gregory, was interviewing a guest who made a forceful case that the U.S. economy had become “very distorted.” In the wake of the recession, this guest explained, high-income individuals, large banks, and major corporations had experienced a “significant recovery”; the rest of the economy, by contrast—including small businesses and “a very significant amount of the labor force”—was stuck and still struggling. What we were seeing, he argued, was not a single economy at all, but rather “fundamentally two separate types of economy,” increasingly distinct and divergent.

Not Everyone Had a Guarantee

One of the first criticisms to the line of logic I've pursued below regarding finance and politics is: what about bailout guarantees? They increase the moral hazard trade, which allows banks to extract rents from the real economy via the state. See, e.g., this post from Macro Resilience and this one by Derek Thompson.

My answer? That doesn't explain hedge funds, which are not TBTF and do not have a bailout guarantee. Nor does it explain insurance, which might have a guarantee post AIG but not before. Nor non-bank mortgage lenders like Countrywide which certainly didn't have a guarantee.

Keep in mind that the top 25 hedge fund managers made more than the CEOs of all of the S&P 500 in one recent year (I think 2007). If that's not coming from the moral hazard trade, then from where?

The criticism I'd anticipate is that hedge funds don't need bailout guarantees if their counterparties in the big banks have one. But that's clearly not true. Tons of hedge funds have lost tons of money in the crisis, and even Bear Stearns' shareholders were practically wiped out. The guarantee might shore up one side of the transaction but not both, and it takes (at least) two to tango.

The Politics and Economics of Finance

Related to my previous post, as well as other recent discussion from Cowen and others. Graph taken from a commenter at Sumner's place (click for larger image).

I've been in a late night Twitter discussion with Steve Randy Waldman over that Sumner post. I summarized much of what I think about it in the post below, but Waldman (and others) think that rent-seeking behavior deserves a much greater role. I disagree, and I also disagree with Sumner on some key points, so here's more fully what I'm thinking right now. I think there are two major shifts, one political and one economic, that does the best job of explaining inequality and finance's role in it:

1. Sumner probably shouldn't've phrased things in terms of "discoverers", nor in terms of "deserve". The former conjures venture capitalists and start-up funding, and that is clearly at least part of what Sumner had in mind originally, but not all. The latter ascribes some normative aspect that i don't think he meant to convey. He would have done better to simply say that finance has done very well at responding to the incentives given them. Those incentives are shaped by a government that wants to please its constituents. Its constituents want funding for houses, for cars, for expensive health care and well-funded retirements. The government incentivizes finance to provide those things at relatively low cost, in exchange for subsidies of various kinds.

Is this capturing of rents? On the one hand, finance has profited very greatly from this arrangement. On the other hand, so have many others, from "subprime" folks who would never have gotten to purchase a home before, to real estate owners/developers, to construction workers, to millions of kids getting student loans. In other words, if there is a "public interest" in having debt spread through the system, can that political economy really be characterized as rent capture by bankers? It seems more nuanced than that.

This is not to suggest that finance doesn't lobby in favor of their interests. They do, as they would be expected to do. Sometimes they win, and their managers and shareholders (including those who invest their pensions and savings in the market) benefit from that. And surely there is some direct sleaziness that goes on, and outright fraud as well.

But that has always been true. That hasn't changed in the past 15-20 years. It hasn't changed in the past 500. It was true in the 1820s, and the 1950s, and the 1980s. What has changed is the rewards going to that sector, and not just in the U.S. You can't explain variation with a static variable. Which makes me think that there is an overarching, dynamic, structural economic story beyond the political dimension, which is my next point.

2. Finance was dealt a very good hand. Technological advances massively reduced transaction costs for capital allocation. Institutional advances -- e.g. the WTO and capital account liberalizations of the past quarter century -- have increased scale opportunities for capital allocation. And, yes, skills investments in things like quantitative finance have also pushed finance's PPF outward. The previously-established financial centers -- New York, London, Frankfurt -- took advantage of those developments. It's not that our generation's financiers on the whole were more gifted than those of previous generations; it's just that the world opened up for finance in a way it hadn't before.

Take an analogy. Professional baseball players make much more money than they used to make. Is this because they are better baseball players? Not necessarily. Is this because society values baseball more than it used to? Probably not, in any normative sense. It's because technological advances have made it possible to watch every game of every team at very low cost. Thus the audience increases, the demand curve shifts right, and the value of a baseball player's labor goes up. Yes, the superstars -- the Jeters and A-Rods and Buffetts and Soroses -- reap much of the reward, but even the average major leaguers and role players make much much more than they used to.

In fact, even if baseball players (financiers) were actually worse than they used to be in absolute terms, their remuneration could still go way up because of advances in other sectors, like technology, that allow them to reach a much larger audience. Going back to finance, there has been a huge global demand-curve shift, and economies that are capable of satisfying that demand (read: first-wave industrialized economies like the U.S. and U.K. that developed large, liquid, robust financial sectors a long time ago) have seen their economies orient more towards finance than in previous generations. We're exporting a lot of that finance as well, in exchange for agricultural and manufactured goods that are often facilitated by our finance sector. And it isn't just the Buffetts and Soroses that benefit, but the typical finance professional as well.

I think that that is what Sumner meant by "deserve" and "discovery" and "capital allocation". At least that's how I read him, and that's what my own thoughts are.

None of this is to say that finance is perfect, or even especially good at efficiently allocating capital to useful purposes. Obviously they mess up, quite horribly at times. Partially because their incentives are screwed up by markets, partially because their incentives are screwed up by public policy, and partially because they just make mistakes. But with the hand they've been dealt it would be almost impossible to not get paid off. And so they have been.

The normative question is whether this shift -- in which more of the economy in housed in finance rather than manufacturing or agriculture, with a concomitant rise in income inequality -- represents a problem for society. The positive question is whether these outsized gains for finance will be competed away once rising economies develop larger, stronger financial sectors of their own, and whether increased competition will lead to increased volatility in the system. This is already too long, so those will have to be the subject of other posts.

An Inequality Post

In the middle of a pretty good post on inequality, Ezra Klein writes:

In the 1970s, median household income begins stagnating. But it's not until the mid-1980s -- and really beginning in 1987 -- that the income share of the top 1 percent begins skyrocketing. ...

What happened in 1987? From about 1952 to about 1986, the top 1 percent's share of income fluctuates between 7 percent and 10 percent. But between 1987 and 1988, it jumps sharply -- rising from 10 percent to 13 percent in a single year -- and never comes back down. So what happened in 1987? There's a massive stock market crash that year, but it's not a crash that's considered to have had profound or lasting impacts on the real economy. Most explanations peg it as a market-driven, rather than economy-driven, event. And yet something that year does seem to have profoundly changed income equality in this country, and in a lasting way. But what?

As it happens I wrote my senior undergrad thesis largely on this question. It's almost a very good question. I say "almost" because Klein (I assume) is using pre-tax/pre-transfer tax return data. If so, 1987 returns reflect 1986 income, so the question should really be "What happened in 1986?" And the answer to that is, quite simply, one of the largest restructurings of the tax code since WWII, the Tax Reform Act. As Showdown at Gucci Gulch describes in detail, TRA86 was all about the distribution of benefits via the tax code, but a few changes would have an especially large effect on measured income inequality after passage.

First, it eliminated many deductions and loopholes, especially for real estate holdings. That meant that a lot of income that was going essentially unreported in 1986, because it was being sheltered, was now reported in 1987. Almost all of that income belonged to the upper tiers of the tax code that could take advantage of those loopholes, so TRA86 shone the light on a lot of income that was previously held in the dark. Second, capital gains income was taxed at the same rate as labor income. Previously, capital gains were taxed at much lower levels than ordinary income -- 20% versus 50% for the top earners. After TRA86, capital gains taxes would rise from 20% to 28%. This heavily incentivized workers that were able to do this to take income in the form of capital rather than cash. These gains would be taxed when realized... but not until then. So quite a lot of income was given to richer workers in the form of stock options and the like, and these were all exercised in 1986 to take advantage of the low rate before it went up. All of this is explained in the very long "summary" report issued by the Joint Committee on Taxation (very large pdf). Third, once corporate and individual tax rates were brought into balance by TRA86, there was a lot of "income shifting" from corporate to individual tax returns.

The net result of these for our purposes is that, among the rich but not the poor and middle classes, a lot of income was reported in 1987 that was not reported previously. So the jump in 1987 was largely a statistical artifact. The rich in 1987 were essentially as rich as they were in 1986, but the vagaries of the tax code meant that the situation looked quite a bit different when looked at in a time series. Alan Reynolds of Cato has written about this quite a lot, see e.g. here. He goes so far as to say that income inequality has basically not changed at all since 1988 (and thus since 1979 or so), and for this he has been beaten down quite severely (e.g. here and here and here and here etc.). But I think he's got this one point -- about 1987 -- basically right.

So do the academics. In their landmark inequality 2003 QJE study, Thomas Piketty and Emmanuel Saez write:

One additional motivation for constructing long series is to be able to separate the trends in inequality that are the consequence of real economic change from those that are due to fiscal manipulation. The issue of fiscal manipulation has recently received much attention. Studies analyzing the effects of the Tax Reform Act of 1986 (TRA86) have emphasized that a large part of the response observable in tax returns was due to income shifting between the corporate sector and the individual sector [Slemrod 1996; Gordon and Slemrod 2000]. We do not deny that fiscal manipulation can have substantial short-run effects, but we argue that most long-run inequality trends are the consequence of real economic change, and that a short-run perspective might lead to attribute improperly some of these trends to fiscal manipulation.

So the shift in 1987 is probably just a statistical mirage. The longer-run shift, encapsulated somewhat by this graph reproduced by Klein, is not.



Derek Thompson takes a stab at it here, and comes away perplexed. Scott Sumner characterized this as a shift in compensation from "producers" (the 1945-1973 economy) to "discoverers" (1973-2010 economy):

Today the most productive members of society are not those who produce things, they are those who discover the things that need to be produced. Once you have the blueprint, it is easy to produce many types of software and pharmaceuticals. The big money goes to those who figure out the blueprint, but also to those who allocate capital to the guy who has the idea for a Google, or Facebook, or Twitter. In contrast, the technicians who actually implement the vision often earn modest salaries. Thus companies are “discovered” in much the same way as an iron deposit is discovered by a skilled geologist.

I think that's part of it. Viewed in that light, the "breaking" of productivity and median compensation comes from the fact that productivity has not gone up because the skills of the median worker have improved, but because the skills of the "discoverer" and those who give him capital have improved. They have improved because of political and technological developments over the past quarter-century or so have pushed the production possibilities frontier way out for those with good ideas and access to capital to develop them. The nouveau riche are not Andrew Carnegie and John D. Rockefeller, but Bill Gates and Roc-A-Fella, and those who finance them.

"Discovery" has become more important because the world's labor supply and consumption markets are now essentially globalized. There isn't anything an American worker can do that a worker someplace else can't do. That wasn't necessarily true in 1945. And even if it was, corporations didn't have the same access to foreign workers that they have now. At the same time, we now have many machines that allow us to produce much more with much less labor. So the supply of labor accessible to markets has increased tremendously over the previous three or four decades at the same time the demand for labor has slowed. If the labor supply curve shifts right, the price of labor goes down. If the labor demand curve shifts left, the price of labor goes down. Viewed in that light it's no surprise that median incomes have stagnated in richer countries.

So, basically, I'd boil it down to two factors:

1. Labor supply (demand) has gotten larger (smaller), depressing the price of labor.

2. Consumption markets have gotten much larger, heightening the price of invention.

Put together, this means rising inequality and stagnating median wages.

This view is not incompatible with Cowen's "short on volatility" story, nor with the economics of superstars. But it doesn't require either of those either, and ultimately I find it more satisfying because it incorporates elements outside the domestic economy. It is mostly incompatible with stories from Pierson/Hacker and Krugman and others that inequality is about rent-seeking and manipulation of the state for private ends, although I think a lot of that goes on too (maybe another post on that soon). In other words, it's mostly an economic story rather than a political story, which is why we see some common trends across countries and not just within them.

The plus side of this, for workers, is that nonmonetary standards of living are going up even if monetary rewards are not. I find the argument that consumption inequality has decreased even as income inequality has increased to be pretty persuasive, and I don't think all of that was pre-crisis credit-based. In 1975 the richest person in the world couldn't own an iPhone; now everyone I know has one. I don't, but I have a Macbook and a flat screen television and easy access to more information and entertainment than almost anyone in history. To paraphrase Eddie Izzard, my standard of living would make King Solomon blush. It just doesn't show up in the statistics.

Politics of Hard Times - Macroeconomic Imbalances Edition

Yesterday morning I attended a panel at the annual American Political Science Association meeting on the macroeconomic and global responses to the financial crisis. Organized by Jeff Frieden of Harvard, the purpose of this panel was to discuss ways to revitalize theory building around the political economy of adjustment. Speakers included former chief IMF economist Raghuram Rajan , former Mexican president Ernesto Zedillo, and UNC professor Layna Mosley (MA thesis advisor to Will, Alex, and me). Overall, I found the discussion fascinating, although I wish that there had been more discussion about whether current conceptual and methodological tools are adequate for this task. Here's a quick run down of some main themes that emerged:

1) Current explanations of the Great Recession tend either to be mainly a macroeconomic imbalance story (without much political economy) OR a political story about regulatory failure due to rent seeking at the domestic political level. IPE scholars need to spend more time thinking about the political economy behind macro imbalances, and the complex interests and institutions that lead to variation in national economic policies. The question hear is why do some structurally important states become borrowers and why do others become lenders? Why do some governments adjust in time to structural imbalances and why don't others?

2) What are the political and economic consequences of an international political economy characterized by some states running persistent current account deficits while others run persistent current account surpluses? Rajan is particularly worried that an increased focus on export-oriented growth is creating a vicious cycle in which countries that would normally be in the best position to stimulate counter-cyclical AD can't because of enduring weakness in the domestic market. If I'm not mistaken, this point speaks to a running debate between Will and Thomas. (Perhaps someone wants to weigh in?)

3) How does growing inequality affect the politics of adjustment? Discussion on inequality focused mostly on the US and stems from Rajan's argument in his recent book, Fault Lines: How Hidden Fractures Still Threaten the World Economy. Rajan argues that technological changes are decreasing the wage advantages traditionally afforded by a college education, and that this effect is particularly important in thinking about inequality more around the 80/20 divide (I have no data on this - I'm assume this is in his book which I'm planning on reading after taking my Methods Comp). For him, the story here is that politicians have dealt with this growing inequality in the most politically expedient way - extending credit to those down the bottom of the distribution. Of course, the point here is that dealing with inequality this way leads to asset bubbles as we saw this time around. (This is the response to Will's post yesterday about performance pay and wage inequality. Rajan's take on this would be that democratic governments have to deal with inequality some way (even if some of rising inequality is merit based, as the 2007 NBER working paper suggests), and the problem is that the quick fix for elected officials is to pursue policies that do not change underlying structural inequality but also lead to increased demand for imports and financial instability.)

4) How has the Great Recession changed the way we study how governments choose to engage markets? This is Layna's main question and speaks to questions about how governments manage their debt, the role of official entities that hold sovereign debt on the rates states must pay to borrow, and whether the idea that advanced industrial countries have "room to move" still holds.

5) What are the prospects for macroeconomic policy coordination and global governance of capital markets when governments are dealing with the domestic politics of adjustment? Zedillo is particularly pessimistic about the future of economic interactions, especially between the US, the Eurozone, and China. Audience member Dan Drezner voiced concern about the politics of fiscal policy as more politically insulated monetary policy tools become less effective at managing downturns.

From my perspective, the take-away from this panel was that we just don't have a robust understand of the political implications of an international political economy with such deep structural macroeconomic imbalances. In order for IPE gain some explanatory purchase over the question panel members raised, we really have to re-conceptualize how to study IPE as a complex dynamic system. It is too easy to revert to a domestic political explanation. What states can do is constrained both by domestic and international politics and economics.

Performance Pay and Wage Inequality

I don't recall reading much discussion of "Performance Pay and Wage Inequality", a paper by Thomas Lemieux, W. Bentley MacLeod, and Daniel Parent, either when it was released as an NBER working paper in 2007 or when it was published in the Quarterly Journal of Economics in 2009 (ungated pdf here). That's too bad, because it is an important paper and does more than any other to answer the perennial question "What has caused the increase in income inequality in the U.S. since the 1970s?" Almost all of the shift in income distribution over that period has accrued to the top 10% of workers, but it hasn't been clear why. Some have argued that the increase in inequality was caused by increased trade openness, changing cultural norms rewarding greed, the decline of labor unions, skill-biased technological change, shifting tax policy that rewarded the rich, and/or increasing returns to economic "superstars" like entertainers and athletes.

The authors make a pretty strong case that it has been because employers have become better able to find and reward more-productive workers for their work, while less-productive workers are left behind. (This is largely consistent with the "skill-biased technological change" explanation, though more specific in theory and causal mechanism.) The abstract:

An increasing fraction of jobs in the U.S. labor market explicitly pay workers for their performance using bonus pay, commissions, or piece-rate contracts. Using data from the Panel Study of Income Dynamics, we show that compensation in performance-pay jobs is more closely tied to both observed and unobserved productive characteristics of workers than compensation in non-performance-pay jobs. We also find that the return to these productive characteristics increased faster over time in performance-pay than in non-performance-pay jobs. We show that this finding is consistent with the view that underlying changes in returns to skill due, for instance, to technological change induce more firms to offer performance-pay contracts and result in more wage inequality among workers who are paid for performance. Thus, performance pay provides a channel through which underlying changes in returns to skill get translated into higher wage inequality. We conclude that this channel accounts for 21% of the growth in the variance of male wages between the late 1970s and the early 1990s and for most of the increase in wage inequality above the eightieth percentile over the same period.

In other words, workers that have earned more have largely deserved to earn more, by objective criteria. Employers have become better at discovering top performers and compensating them accordingly. Top employees have become better at finding ways to demonstrate to employers what their true value is. Over time, more jobs have included performance pay as some or all of their compensation, so inequality has increased. The striking thing is that this explains almost all of the inequality increase in the 80th percentile and above, which is where almost all of the increase in inequality has occurred. It's a powerful paper.

This isn't as sexy or sinister as other narratives of increasing inequality, but it makes sense. Technology has made it easier to demonstrate and assess productivity, especially in information-intensive professions. The information technology sector has increased relative to traditional salaried sectors like manufacturing. Hence, inequality has increased.

I'm amazed that this wasn't covered more in blogosphere. Is it because it contradicts some sacred cows?

Anyway the news that the American political economy is not unjustly controlled by the rich using their power to extract rents should be welcomed by everyone. In other words, we should be very pleased that we do not live in a "New Gilded Age", at least if that's defined by robber-barons seizing wealth that they were not entitled to. This paper is evidence that the wages are distributed more fairly than most of us had thought.

Envy, Altruism, and Trade Policy

KPC points to a NBER working paper by Lu, Scheve, and Slaughter on the politics of trade policy (ungated pdf here). The abstract:

One important puzzle in international political economy is why lower-earning and less-skilled intensive industries tend to receive relatively high levels of trade protection. This pattern of protection holds even in low-income countries in which less-skilled labor is likely to be the relatively abundant factor of production and therefore would be expected in many standard political-economy frameworks to receive relatively low, not high, levels of protection. We propose and model one possible explanation: that individual aversion to inequality—both envy and altruism—lead to systematic differences in support for trade protection across industries, with sectors employing lower-earning workers more intensively being relatively preferred recipients for trade protection. We conduct original survey experiments in China and the United States and provide strong evidence that individual policy opinions about sector-specific trade protection depend on the earnings of workers in the sector. We also present structural estimates of the influence of envy and altruism on sector-specific trade policy preferences. Our estimates indicate that both envy and altruism influence support for trade protection in the United States and that altruism influences policy opinions in China.

This is an original thesis and utilizes some nifty methodology, and I have no doubt that it will be published in a top journal. It continues what appears to be a growing trend of analyzing social attitudes as determinants of public policy. See also this article from last year on sociotropic attitudes by Mansfield and Mutz. But I have some concerns. (I've only skimmed the paper, not dissected it thoroughly, so these thoughts should be taken as provisional.)

Here is the causal mechanism the authors propose:

1. Policy preferences of citizens are motivated by egalitarian feelings of envy and altruism.

2. These feelings manifest themselves as support for trade protectionism.

But #2 does not necessarily follow from #1. It could just as easily be something like:

1. Policy preferences of citizens are motivated by egalitarian feelings of envy and altruism.

2. These feelings manifest themselves as support for trade openness -- thus capturing the social gains from trade -- coupled with a robust social safety net financed by progressive taxation -- thus compensating the losers and narrowing relative inequalities.

Or, to stick with the logic of collective action that is commonly applied in trade analysis, we might expect trade protection for labor because:

1. If it is the abundant factor of production (and would therefore benefit from an open trading system) then it will have difficulty mobilizing a coalition to effectively lobby for openness. The smaller anti-trade coalition may feel envious or not, but it's basically irrelevant.

2. If it is the scare factor (and would therefore be hurt by an open trading system) then it will be able effectively lobby for closure. The larger anti-trade coalition may fell altruistic or not, but it's basically irrelevant.

In other words, attitudes may correlate with behaviors, but that doesn't necessarily imply that one motivates the other. At least, it doesn't erase basic interest-based motivations in previous trade models. They try to get at this with interview data, but there are always reasons to be skeptical of self-reported motivations.

I'll try to give it a more thorough examination when I have more time, but for now I don't see anything in the Lu/Scheve/Slaughter analysis that eliminates alternative explanations. This is a problem, since we have lots of previous literature that supports more traditional views.

[Edited slightly for clarity at 6:30pm]

The Dumbest Thing I've Read in Awhile

In a book review Lynsey Hanley of The Guardian says that economic growth should be abolished:

We are rich enough. Economic growth has done as much as it can to improve material conditions in the developed countries, and in some cases appears to be damaging health. If Britain were instead to concentrate on making its citizens' incomes as equal as those of people in Japan and Scandinavia, we could each have seven extra weeks' holiday a year, we would be thinner, we would each live a year or so longer, and we'd trust each other more.

Epidemiologists Richard Wilkinson and Kate Pickett don't soft-soap their message. It is brave to write a book arguing that economies should stop growing when millions of jobs are being lost, though they may be pushing at an open door in public consciousness. We know there is something wrong, and this book goes a long way towards explaining what and why.

Via Yglesias, who claims that equality leads to growth (which may or may not be true) but dances around the main point which is exemplified by the part I bolded: in the absence of growth, everybody is made worse off, but the people at the bottom of the social scale suffer disproportionately. When growth suffers, those with the fewest skills and lowest levels of education are the first ones to lose their jobs and homes. As Krugman noted the other day, the American economy requires a 2% growth rate just to maintain a constant employment rate, and faster growth rates are strongly associated with lower unemployment. This is especially true for those at the bottom of the social scale (including, as Yglesias mentions, unskilled immigrants from poor countries).

But even if all of that were not true, this argument still makes no sense. Whether equality fosters growth (as Yglesias maintains) or growth fosters equality (as I suspect), the richest countries in the world tend to be the most equal. The map above shows Gini coefficients for the world in 2007-2008, as reported in the U.N. Development Report (click here for a larger version). A higher Gini coefficient refers to a more unequal society. So what do we see? Countries that are rich tend to also be more equal than countries that are poor. And how to do you get rich? There is only one way: economic growth. So perhaps the best way to address within-country inequality is spend more effort trying to maximize growth. If we seek to address between-country inequality, then our only alternative is a pro-growth strategy for the developing world. And in recent times, the most successful growth models for emerging economies is to be export-led. But who buys the exports? The developed world. And how can the developed world afford to buy those exports? I think you can see where I'm going with this.

Of course, I haven't mentioned the importance of absolute as well as relative levels of wealth, the underrated benefits of compounding growth rates, the social (in)justice of legislating the preferences of some (for more leisure relative to income, say) as mandates for others, the importance of incentives, or the sheer unholy slap-your-forehead dumbness of Hanley's second sentence: "Economic growth has done as much as it can to improve material conditions in the developed countries."

No it hasn't. Not by a long shot.