Making the Rich Work for You

Whether you measure inequality in silly and deceitful ways, or whether you do it with emojis, economic inequality definitely exists. Some people have more of what all people want to have more of; some have less. Okay, so what?

Almost everyone agrees that economic inequality is bad. Almost nobody agrees why. Depending on whom you ask, you’ll hear that the main problem is:

1. The poor are too poor.
2. The rich are too rich.
3. What’s lacking isn’t equality of outcomes, but of opportunity, meritocracy, and social mobility.
4. It just ain’t fair.

A cynic would posit that you care about (1) if you’re poor, (2) if you’re a middle class liberal, (3) if a middle class conservative, (4) if you’re a prioritarian-egalitarian ethicist or a rhesus monkey. I’m half cynic: I’ll agree that all four issues merit discussion, and will do so from an economist-utilitarian perspective, starting with these pesky rich people.

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Grabbing your stuff

Robin Hanson probably doesn’t call himself an economist-utilitarian (abbreviated econut), but he knows more about both these topics than almost all. How does he explain the fact that so much of inequality talk is focused on the very rich?

He notes that inequality between households within a single country is much smaller than inequality between species, between humans of different eras, nations and talents, even between siblings in the same household. So why do we focus so much on it? Because we can envision successfully doing something about it, i.e. grabbing some of the money from the rich in our country and taking it for ourselves. We can’t effectively grab the money of people in a richer future, or from someone in a richer country across the world. If the rich had actual super powers that protected them from grabbers, for example if the richest group in the US were the X-Men or the Avengers, we wouldn’t rush to complain about the 1% as quickly. If the super powers of the richest 1% are things like “knowing how to consistently allocate venture capital to achieve above-market returns”, we feel safe going after their dollars.

 

Even if complaining about the inequality of the rich is hypocritical, it may still be useful to an economist-utilitarian. The economist side will check whether there are detrimental effects on the economy as a whole from either the concentration of money in the hands of the very rich, or the attempts to tax them. Whether there are or not, the utilitarian side will recognize that redistributing some money from the rich to everyone else may still be positive because of the diminishing marginal utility of money. Someone with a lot of dollars doesn’t get as much enjoyment out of every additional dollar – there’s only so much good soap one can use. The economist will want to make sure that the redistribution is effective, and doesn’t distort incentives in a harmful way.

Let’s put our econut hats on and see if we should try to grab some money from the rich, and if so what’s the best way to go about it.

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Do we all grow slow when the rich have mo’ dough?

Probably no. It’s easy to find people proclaiming that it’s the case that concentration of income hurts growth, but the actual case is hard to find. Forbes magazine, not normally a bastion of socialism, offers an article entitled “Increasing Inequality Hurts Economic Growth“. For evidence, the article links only to this research by the OECD. The only chart in the OECD piece with actual data (and not speculation) shows inequality rising fastest in Finland, Sweden, New Zealand, Israel and the USA, while falling in Turkey and Greece. I know which of these groups I want to be in. Even if the correlation is in the correct direction, I couldn’t find a reason why slow growth is caused by inequality rather than the other way around.

Forbes explains that “Growth happens when lots of people spend money. In the U.S., for example, the small number of people at the top of the economic ladder can’t consume and spend at the rate that the broader population can.” The rich indeed save more and spend less of their income, but their savings are (presumably) invested in productive assets like stocks and not kept in the form of a gold-coin swimming pool to dive in. Macroeconomists have debated for a century whether consumption or investment is better for the economy, it’s far from obvious that consumption is the answer. The Forbes article also claims that “The distribution of income means that there are many more in the bottom 40 percent by income than there are in the top 40 percent by income.” which is either a silly typo or an entirely new way to do math.

The Economist also chimes in and suggests a mechanism by which insufficient spending can hurt the economy:

[The] governor of the Reserve Bank of India, argued that governments often respond to inequality by easing the flow of credit to poorer households. Other recent research suggests American households borrowed heavily prior to the crisis to prop up their consumption. But for this rise in household debt, consumption would have stagnated as a result of poor wage growth. Economic eminences such as Ben Bernanke and Larry Summers argue that inequality may also contribute to the world’s “savings glut”, since the rich are less likely to spend an additional dollar than the poor. As savings pile up, interest rates fall, boosting asset prices, encouraging borrowing and making it more difficult for central banks to manage the economy. 

So the rich spending less money makes it hard for central banks to respond to how non-rich people react to government policies? It’s hard to find any coherent cause or effect in that paragraph, let alone see how “inequality” is either of those. I am not an economist, but to a layman this paragraph sounds roughly like:

The CEO of Haagen Dazs argued that ice cream makers respond to inequality by making vanilla ice cream cheaper. Other research suggests that Americans ate more vanilla ice cream to prop up their sweet tooth. But for the rise in vanilla ice cream sales, consumption of ice cream would have stagnated. Ice cream eminences such as Ben and Jerry argue that inequality may also contribute to the world’s “ice cream in fridges glut” since rich people are skinnier and eat less ice cream. As sales of vanilla ice cream pile up, it makes it more difficult for Ben and Jerry’s to sell chocolate ice cream.

Maybe there’s good evidence on concentration slowing growth that my Google-fu didn’t turn up. Maybe I misunderstood the fine points of Forbes’ and Economist’s arguments because I’m not actually an economist (very different from an economist-utilitarian). But just maybe, there’s just no good reason to believe that the average does worse when the rich do better.

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The working wealthy

If letting the rich keep their money isn’t destructive, maybe taxing them is. Just for lulz, I went back to Forbes for a different article, this time arguing that taking money away from the rich people who earned it  is what hurts the economy:

When the top marginal rate was 90 percent, actor Ronald Reagan worked just half the year. As soon as he made enough money such that every additional dollar was taxed at 90 percent, he stopped working and went off to ride horses.

Before I drop my two cents on taxation and work incentives, I want to note that giving people more time to ride horses seems like a net benefit in my book.

The way Americans whose parents aren’t rich get to the 1% is with an advanced professional degree. Med school is hard and law school is risky, the path of least resistance to being rich is one of the top 50 MBA programs. Practically all of these have placement rates above 90% and starting salaries north of $100k. All it takes to get on an MBA track is a GMAT score above 650 (roughly correlates with an IQ above 120), and ability to grind a corporate career without fucking up too bad. Basically, you need above average (but not exceptional) intelligence, ambition, grit and political acumen.

The interesting question is, what would today’s MBAs be doing in a different system, with different taxes, incentives and power structures? I know hundreds of these kinds of people from around the world, and the answer is almost certainly never “sit at home and wait for welfare”. After all, the diminishing utility of money should have roughly the same effect as a progressive tax rate (you get less and less from each dollar you earn) and yet richer Americans work more hours than anyone.

The four qualities are quite general, and by themselves leave a lot of room for vastly different career paths. In the current US economic system, they will get you a six figure income in the private sector. Countries like Israel or India are focused more on technology, so people with the above skillset study engineering instead of finance. In a country like Chile where public servants earn much more than average, you’ll find more of them in the public sector. What were smart, ambitious people who work hard and get along with bosses doing in a place like the Soviet Union? They probably joined the Communist Party and worked their way up the party ranks. In America you go into business to be able to party, in Soviet Russia…

Like electrons in a parallel circuit, people with the potential to rich the economic top will get there by whatever path offers the least resistance. If the circuit is broken (for example if a country is broke or distributes money solely based on heredity), these people will be the first to leave. Short of reverting to feudalism, changing incentives will mostly affect where talented people work (industry or country), it probably won’t make them stay home.

Paul Graham agrees with me:

I’m all for shutting down the crooked ways to get rich. But that won’t eliminate great variations in wealth, because as long as you leave open the option of getting rich by creating wealth, people who want to get rich will do that instead.

Most people who get rich tend to be fairly driven. Whatever their other flaws, laziness is usually not one of them. Suppose new policies make it hard to make a fortune in finance. Does it seem plausible that the people who currently go into finance to make their fortunes will continue to do so but be content to work for ordinary salaries? The reason they go into finance is not because they love finance but because they want to get rich. If the only way left to get rich is to start startups, they’ll start startups. They’ll do well at it too, because determination is the main factor in the success of a startup. And while it would probably be a good thing for the world if people who wanted to get rich switched from playing zero-sum games to creating wealth, that would not only not eliminate great variations in wealth, but might even exacerbate them. In a zero-sum game there is at least a limit to the upside. Plus a lot of the new startups would create new technology that further accelerated variation in productivity.

 

Graham also notes the importance of incentives in directing where productive people choose to apply themselves. In the last three decades more and more of America’s 1% make their money in finance. I know quite a few people with truly outstanding, 1-in-10,000 mathematical talent. A disconcertingly high percentage of them work in hedge funds, where it can be argued (in great technical detail) that they contribute nothing productive to the economy, do nothing useful for the clients, and basically waste their incredible talents competing with each other in a pointless zero-sum game. They are not bad people, hedge funds just pay mathematicians more than saving humanity does.

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Ok, so we can probably grab some money from the rich without destroying the economy, but we need to do it in a clever way that will not incentivize them do anything harmful. That’s one benefit of dealing with the rich: almost by definition they respond better to economic incentives than other people (*cough* Brexit *cough*).

Different tax systems have their own benefits and drawback, and a discussion of all of them will take a while. Unfortunately, I have a flight to Iceland in two hours and that discussion will have to wait until I return in two weeks. I’m sorry to leave you on a tax-policy cliffhanger, but I really need to go.

My bad :)