Wednesday, January 25, 2012

Yes, you can make money without exploiting the poor, but...

I was (briefly) a guest on a BBC World Service radio program this morning discussing Obama's state of the union speech and income inequality in general. To my mind, this has always been a no-brainer. My argument is: we've done this experiment (of lowering taxes on the rich) twice now, once in the 1920's and again in the 1980's (and doubled-down in 2000). We have also done the control experiment. Between 1945 and 1980 top marginal tax rates in the U.S. ranged from 70 to 90%.

The results are clear: high marginal rates correlate with broad-based economic prosperity and an expanding middle class. Low marginal rates correlate with extreme income inequality, reduced prosperity overall, and ultimately, economic catastrophe.

Now, correlation does not imply causality. Economies are enormously complex systems. And one of the guests on the program dismissed my argument as "not being accepted by economists." To which I say, this would not be the first time economists have been wrong about something. But I freely concede that while the data are suggestive, this is not a slam dunk. In particular, it certainly does not prove (and in fact I do not believe) that raising taxes on the rich by itself will solve all our problems. The data do, however, convincingly falsify the opposite theory, that lowering taxes on rich people results in economic prosperity, and raising them causes unemployment.

The real problem is not really tax rates per se. The real problem is the power asymmetry that is invariably results from lassez-faire capitalism. Capitalism depends on competition in order to function properly, otherwise it devolves into fascism. But the problem is there is more than one way for a company to succeed. One way is to provide a superior product at a lower price, but another is to engage in rent seeking behavior like lobbying legislators to pass laws that favor entrenched interests at the expense of potential competitors or using your economic clout to bias binding arbitration proceedings in your favor.

In short, naked capitalism does not distinguish between success that arises from successful competition and success that arises from gaming the system. Angelo Mozilo made $40 million net of SEC fines (and 34 million net of taxes) for bankrupting Countrywide and helping to precipitate the greatest economic catastrophe in three generations. But his dollars buy just as many yachts, private jets, and politicians as someone who made their money by bringing an actually useful product to market.

After I was kicked off the BBC radio program the question was raised: can you make money without exploiting the poor? The answer I would love to have given is: yes, clearly it is. But it's a lot easier to make money if you do exploit the poor, so in the absence of some countervailing force, those who choose to exploit the poor will win, at least in the short term.

In the long term, of course, they will lose. But so will everybody else.


Anonymous said...

Do you know at which time this was? There are archives at - but you are not in the segment which is listed as the segment on the state of the union.

Ron said...

The show started at 10AM PST. I was brought in about 15 minutes later and kicked off about a minute after that. I don't know if it was live or not.

Anonymous said...

Ah, of course, morning for you :-) , from 16:40 on.

Don Geddis said...

As you say, "correlation does not imply causality". It's telling that the people who study this professionally (aka economists) don't at all agree with you that you have properly identified a causal connection.

Either way. Even your "convincingly falsify" direction does not at all match mainstream economic consensus.

Yes, maybe economists are wrong. But you, sitting in your chair and musing for ten minutes, are unlikely to have discovered profound wisdom about the world that never occurred to them.

Also, "exploiting the poor" isn't really a well-defined concept. But even if it were, it makes up only a tiny fraction of all world economic activity. I'm certainly not going to claim that it never happens. But at the same time, this is hardly a typical story about wealth creation in capitalism.

In both cases (taxes, exploitation), I think you've confused "anecdote" with "data" and "general theory".

Ron said...

> maybe economists are wrong

It would not be the first time. The economic consensus in 2005 was that everything was hunky dory. (And, BTW, there is evidence that the *reason* that the economic consensus was so wrong was -- and is -- that the economic profession has been thoroughly corrupted by Wall Street. c.f. the movie "Inside Job".)

But I do not claim to have identified a causal connection, nor to have discovered profound wisdom. I am just pointing out a historical fact: in the United States for the lat 100 years or so, low marginal tax rates are strongly correlated with high unemployment (with a lag of 5-10 years), and vice versa. This is very strong evidence that theory often advanced on the right that raising taxes on rich people kills jobs is false.

I concede that "exploiting the poor" is not a crisply defined concept. But so is "pornography" and most people have no trouble identifying it when they see it. When your workers start to commit suicide en masse that is a pretty good clue.

Don Geddis said...

Ron said: "The economic consensus in 2005 was that everything was hunky dory."

You state this as though it was "obviously" wrong, but the truth is far from clear. I, for one, have become convinced over the last few years that the 2005 economic consensus was actually correct. Yes, of course real history didn't unfold that way. But that does not mean there was an error in forecasting, given the information available at the time.

The Great Recession of 2007+, was not a consequence of the economic conditions in 2005. That's the critical mistake in your reasoning.

I will grant you that the theory that "raising taxes on rich people kills jobs" is not at all supported by the evidence. That's just empty political rhetoric on the right, and not an actual economic theory. I agree with you there.

As for definitions ... pornography (as difficult as it is), is actually easier than exploitation. People might disagree on whether a particular work is pornographic or not, but at least they agree on what it would be for something to be pornographic. The work would assist in raising sexual excitement. Now, perhaps that's a relationship between the individual and the work, rather than being an inherent property of the work itself. But at least we know what we're getting at, even if there is difficulty in absolute classifications.

But "exploitation" ... presumably you intend to mean something more significant than "bad", or "I don't like it". But at the end of the day, what you have is people who are living in desperate situations, and someone offers them an optional job. Whatever it is, that is one more option than they had before the job came along. It's hard to reconcile the facts on the ground, with the accusation, "exploitation".

Most people just use it as a gut emotional reaction. They look at the lives of these people, and imagine their own anger if they were forced to lives those lives instead of the comfortable ones they actually have. But what most people fail to pay much attention to, is what kind of lives are being led before this job was ever offered?

A job can simultaneously both be "really bad", and also "much better than what was there before". Labelling it "exploitation", and then returning to the previous state, without the job being available, is not necessarily an improvement in the worker's lives.

Ron said...

> The Great Recession of 2007+, was not a consequence of the economic conditions in 2005.

You can't possibly be serious. Two comments ago you were giving me a hard time for not distinguishing between anecdotes, data, and theories. You don't even have an anecdote, just a bald-faced assertion that is so plainly at odds with the facts that it is not even worth debunking.

Coming up with a workable definition of "exploitation" turns out to be a worthwhile exercise. That's a topic for another blog post.

Don Geddis said...

Re: exploitation. Great! I look forward to your future post.

Re: economics. You are correct that I made no attempt to defend my assertion. It's a complex question, one hard to resolve in a blog comment.

I just want to point out that all you have (again!) is correlation, and you're inferring causation. There were some economic conditions in 2005, and others in 2008, and everybody wants to tell some obvious story that 2008 was a consequence of 2005. Humans understand the world in terms of narrative: good vs. evil, intentional actors making decisions, etc.

But if you actually take a scientific approach, and start diving into the data, the connection is far more tenuous than most people believe.

The mainstream layman narrative is something like: evil rich greedy Wall St people took outsized risks, and as a consequence we're all now suffering. But that causal narrative is not supported by the economic data. The first happened, and then the second happened, but the second was not "caused" by the first.

I have no hope of convincing you of that truth in a brief blog comment. I only hope to shake your confidence a little bit, that you believe you understand the US macroeconomy over the last five years. I think your understanding is in error.

If you care to spend time learning about why the Great Recession did happen, I would highly recommend The Money Illusion. When the definitive economic history of the last half-decade is written, a decade or two from now, I confidently predict that Scott Sumner's ideas will be at the forefront of that explanation.

(The answer, by the way, is: the subprime mortgage collapse caused a minor blip in the economy, which later fell off a cliff because the US Fed choose not to maintain stable growth in nominal GDP in 2008, in the way they had for the previous three decades.)

But I also realize that few ordinary people have the time or interest to spend the effort to learn about this stuff. So I'm not asking you to. I'm just asking you to be a little less confident that you have properly identified why our economy got to where it is right now. That you know who to blame, and what should be done to fix it from happening again in the future. I think you (and the vast majority of the public, of course -- you're in good company!) are vastly misinformed about what happened and why.

Don Geddis said...

I suspect that hardly anyone here cares about studying macroeconomics. But if there are a few who might, I can offer a couple more links.

Wilson offers a clearer summary of Sumner's ideas, than Sumner himself typically does.

Nunes offers two great graphs of nominal GDP (US and OECD) over the last half-century, clearly showing the inflation in the 70's, the moderation from 1980-2005, and the crash in 2008 (from a long post).

And if you prefer video, Scott Sumner himself has a 15 minute video clearly explaining what caused the Great Recession.

(This is in response to Ron's criticism that I didn't even provide an anecdote, just an assertion that was "not even worth debunking". Hopefully, the new claim that US Fed caused the recession by allowing NGDP to plummet -- as opposed to greedy bankers taking risks -- is now sufficiently supported that it is at least "worth debunking".)

Ron said...

> I suspect that hardly anyone here cares about studying macroeconomics

I do.

> Wilson offers a clearer summary of Sumner's ideas, than Sumner himself typically does.

Yes, I've read Wilson. This is not what we are disagreeing about. What we are disagreeing about is much more fundamental. It has more to do with this:

> is now sufficiently supported that it is at least "worth debunking"

Yes. Now that I actually know your argument I can (and will) debunk it :-) (as soon as I finish all the other stuff I have to do today).