Tuesday, January 05, 2016

My simplified response to Paul Graham's simplified essay

Paul Graham published a simplified version of his essay on income inequality.  Here's my simplified response:

It is true that many socially worthwhile activities (like developing technology, and starting startups) produce income and wealth disparities.  And a certain amount of income and wealth disparity is not a bad thing.  In fact, having no income and wealth disparity is a bad thing.  We tried it.  It didn't work.  No reasonable person disputes this.

However, too much income and wealth disparity is also not a good thing.  I hope I don't have to convince you that if all of the wealth in a society is controlled by a single family or individual, that's not good.  The optimal point lies somewhere in between those two extremes.

Today, the top 1% control fully half of the planet's wealth.  That is awfully close to the second extreme.  It's very unlikely that this is where the happy medium lies.

It's particularly worrisome because, as income and wealth disparity increases, there is a positive-feedback effect that tends to drive it further and further towards the second extreme: the extremely wealthy use their disposable income to buy political influence, which they then use to get laws passed that favor them at the expense of others (e.g. through regressive taxation).  This lets the already-wealthy accumulate more wealth not by creating more value, but by collecting economic rents.  In the long run this leads to oligarchy and possibly even economic and societal collapse.  We are nowhere near there, but by the time it becomes apparent that this is happening it will almost certainly be too late to do anything about it.  The time to act is now, before it becomes an even more serious problem.

(Paul Graham, like nearly everyone in today's politics, fails to appreciate the near-universal validity, at least when it comes to social and economic policy, of Ron's First Law: All extreme positions are wrong.  :-)

29 comments:

Matt McKnight said...

The Oxfam statistics are extremely misleading. You should remove that from your piece.
http://fusion.net/story/39185/oxfams-misleading-wealth-statistics/

Ron said...

@Matt:

I dunno, Felix Salmon seems to be whittling at the margins here. It doesn't really matter whether the top 1% have as much as the bottom 50%, or whether it's the top 2% that have as much as the bottom 40. The point remains that we're most likely closer to the second extreme than the happy medium. And there is no doubt that we are *moving towards* the second extreme. Exactly where we are in this process seems like a minor quibble to me.

Geoffroy Tremblay said...

Wow! to say that we've "tried it" by pointing to the fail experiment of soviet union communism is quite short sighted to say the least. I know it's a little off topic, but there is other ways than capitalism ;) We have to keep our eyes open as a society who struggle with a sick monetary system.

Rob said...

Both you and Paul Graham are correct. The distinction that needs to be made is that of economic versus political entrepreneurship. There is nothing wrong with founders becoming extremely wealthy and the resulting wealth disparity as long as that wealth isn't then used to extract economic rents via the political process.

Kimi Merroll said...

Agree that income inequality has consequences and I have been following the discussions on this topic, but I haven't seen anyone state explicitly what the proposal(s) are to address income inequality. Social policies like progressive taxation, privatization, production controls sound too much like a state sponsored power grab further than what most of us are probably comfortable with. We understand the issue, but, again, what are you proposing to address income inequality?

Luis said...

I've also found a little too far to conclude from ONE failed attempt that "(...) having no income and wealth disparity is a bad thing.". The bad factors were (probably) not the lack of income and wealth disparity. The main factors for failure were most likely the sheer size of the territory, the cultural differences among the heterogeneous population and a non-transparent concentration of power in the hands of few.

Vageli M said...

"In fact, having no income and wealth disparity is a bad thing. We tried it. No reasonable person disputes this."

Are you saying that there was no wealth disparity in the Soviet Union? Do you have any sources to back that up besides blindly linking to wikipedia and attacking people that might dispute this "fact" (implying only unreasonable people would have issue with your claim)?

Tommy McGuire said...

Rob,

There is no difference between "economic entrepreneurship" and "political entrepreneurship" (whatever you mean by those phrases). Beyond some point, the sole additional marginal value of another dollar is that it increases your political power.

Further, "economic rents" (or anything economic for that matter) are the least of the problems with wide economic and political power disparities: Henry Ford fired employees he found drinking.

Ron said...

@Luis:

It's actually not true that the Soviet Union is the only data point we have. There have been a lot of small-scale experiments in economic equality, most notably communes and kibbutzim. My father actually grew up on a kibbutz. They kibbutz system has not completely collapsed the way the Soviet Union did, but the egalitarian ideal is almost universally recognized as a failure. See e.g.: https://en.wikipedia.org/wiki/Kibbutz#Private_property

Unknown said...

Millions of families, clans, tribes, sects and entire cultures have employed egalitarian modes of organization with success over widely varying spans of time. Clearly the centralized manual command closed economy is a gross failure, repeatedly, but that's a pretty small set of cases, generally associated with nation-states, which are arguably a failure in themselves, in the grips of a profoundly defective ideology. Generalization from such extreme outliers should only be done with great trepidation.

Printing money to pay off the debt burden which is frustrating economic growth would have the effect of devaluing hoards, and printing enough to provide basic income would decisively solve problems of poverty. The result would be expanding consumption, expanding economic activity, expanding hopes and aspirations, expanding horizons of productive creativity.

Why is no one competent to advance this agenda?

Ron said...

@Vageli:

> Are you saying that there was no wealth disparity in the Soviet Union?

No, but that was their goal.

Steve Eldridge said...

The issue is not in the individual accumulation of wealth per se but the future disbursement by means of successive generations as the sole measure of generational wealth accumulation and the commingling of power by progeny alone.

"Separate an individual from society, and give him an island or a continent to possess, and he cannot acquire personal property. He cannot be rich. So inseparably are the means connected with the end, in all cases, that where the former do not exist the latter cannot be obtained. All accumulation, therefore, of personal property, beyond what a man's own hands produce, is derived to him by living in society; and he owes on every principle of justice, of gratitude, and of civilization, a part of that accumulation back again to society from whence the whole cameI" - Thomas Paine

If you want to begin the conversation on wealth, we have to turn not from the accomplishments of a single person at one point in time but the question of inheritance granting the vast accumulation of idle wealth which leads to the assumption that a genetic lottery is accomplishment itself.

The most critical founding principle of the United States was the complete rejection of an degenerate Aristocracy as a means of ruling men. Oddly a number of our populace is looking to place the leadership of the county into the hands of a man who's most significant accomplishment is being born into wealth having never been responsible for earning his own way, or participated in such mundane concepts as having been subject to a job interview to earn the privilege to oversee anything in his entire life.

This is precisely what motivated the founding fathers to seek a new form of governance.

Generational wealth is what causes a society to become unbalanced.

Don Geddis said...

Ron: As before, I disagree with your general perspective. But I'll try to be specific:

"I hope I don't have to convince you that if all of the wealth in a society is controlled by a single family or individual, that's not good." This confuses the very point that Graham was trying to clarify: is the problem poverty, or is it inequality? Much of the horror of a single family controlling "all of the wealth", is that everyone else has nothing. But it's a very very different situation, if everyone else has a whole lot of resources too. The question you aren't fairly exploring, is what is society like when there is a lot of income/wealth inequality, but without poverty?

"Today, the top 1% control fully half of the planet's wealth. That is awfully close to the second extreme." No, it's nothing at all like the second extreme. You shouldn't be using your gut intuition to try to explore these cases. You actually need to think about them. The reason global wealth is so concentrated, is that about half of living human beings live a subsistence existence, essentially without the benefit of the industrial revolution. That poverty is the problem, not the wealth of those more fortunate. And in fact the solution to that poverty surely involves capitalism, which is essentially the opposite conclusion you seem to be leading towards.

In fact, the greatest total improvement in human welfare in the last century, was the secret adoption of capitalism in China. That shows the one clear way to make poor societies, rich.

" the extremely wealthy use their disposable income to buy political influence" This is the key to your entire claim, but I don't believe "the rich" have anywhere near the political clout that you attribute to them. Hence I reject your conclusions.

Don Geddis said...

@Steve Eldridge: "Generational wealth is what causes a society to become unbalanced."

The problem you're worried about, is only a minor, trivial issue in the modern U.S. You seem to have a model that matches nobility in the middle ages, of powerful families that existed across centuries. That's not how wealth behaves in the modern world. A more accurate pithy summary of the typical case is "shirtsleeves to shirtsleeves in three generations.

Even within a single generation, most individuals and families find themselves in many different income categories during their lifespans.

Peter Donis said...

@Ron: "the extremely wealthy use their disposable income to buy political influence...In the long run this leads to oligarchy..."

You might recall that in the discussion on your previous post on income inequality (your response to Paul Graham's original post on the subject), you claimed that anarcho-capitalism would devolve into oligarchy, and I responded that in that case, we're screwed, because oligarchy isn't a bad description of what we have now. I find it interesting that in this post, in the passage quoted above, you are basically agreeing with me. :-) (You do say what we have now will only lead to oligarchy "in the long run", but this concedes the essential point.)

Peter Donis said...

To amplify a bit more on my previous post, which I couldn't resist leaving as it is :) --

@Ron: "The time to act is now, before it becomes an even more serious problem."

But what should we do? That's the question.

Your general policy prescription (not from this discussion but from your overall corpus of blog posts) seems to be "democracy". But democracy is what got us to where we are now. In other words, democracy devolves into oligarchy. (Which is why I say we're screwed if anarcho-capitalism also devolves into oligarchy.)

More specifically, I would expect you to say something along the lines of: convince people to vote for enough redistribution of wealth to reduce income inequality to an "acceptable" level. But who gets to determine what an "acceptable" level is, and how do they do it? And how do we keep whatever system gets put in place for determining the "acceptable" level from being gamed, the same way all the other rules that were supposed to keep rich people from having too much political power have been gamed?

It seems to me that, if the root problem is that there is a positive feedback loop between income inequality and political corruption, then the obvious way to fix the problem is to break the feedback loop. Trying to redistribute wealth doesn't do that; at best it damps the feedback somewhat, but it doesn't take it away. The weak link in the feedback loop is not the "accumulation of wealth" link; it's the "use wealth to buy political corruption" link.

In other words, the problem is not that rich people can buy political corruption; the problem is that political corruption is available for sale in the first place. And the reason for that is: centralized government. If the government doesn't control or regulate something, there's no way for rich people to buy political corruption to mess with it. So it seems to me that the obvious way to fix the feedback loop is to reduce the number of things that are controlled or regulated by the government.

Don Geddis said...

Peter Donis wrote: "If the government doesn't control or regulate something, there's no way for rich people to buy political corruption ... the obvious way to fix the feedback loop is to reduce the number of things that are controlled or regulated by the government."

I agree with Peter, here. I'm not coming from the same place (I'm not a fan of "anarcho-capitalism", and agree with Ron that it probably looks more like Somalia than utopia, and also that it's likely unstable, as those who remain individuals eventually lose a battle of arms against those who choose to organize into states.)

But, that said, I'm hugely suspicious of non-market ("governmental") failures. The common pattern seems to be: a need is discovered, a governmental policy is suggested with the best of intentions, the real-world solution that gets implemented fails due to some kind of corruption or gaming, and then there is lots of hand-wringing about morality, and how the solution would have worked "if only" people were different than they are.

Seeing this pattern often enough, my conclusion is that government intervention should only be used when the predicted benefits are obvious and overwhelming. The default case should be "no intervention". Even when observing a typical market failure; the cure is often worse than the disease. You need to be really sure of what you're doing, before bringing the force of government to dictate the solution on some issue.

Ron said...

@Don:

> You want a similar example in 1990's IPO evaluations. This is easy; there were many. Take, for example, Henry Blodget.

You are undermining your own argument here, because...

> Blodget is now barred from working in the securities industry for life.

So Blodget was punished. Not so for the vast majority of subprime fraudsters.

> I don't believe "the rich" have anywhere near the political clout that you attribute to them.

What can I say? I've given you a reference which contains a fairly extensive bibliography. I can also give you a data point from my own personal experience: I regularly get invited to meet with senators and congresscritters, and I'm pretty sure it's not because they want to avail themselves of my acute political acumen.

@Peter:

> oligarchy isn't a bad description of what we have now

Well, I don't think we're quite there yet. But we do seem to be headed in that direction if we don't do something.

> But what should we do? That's the question.

A fair question, and writing that blog post is on my to-do list. But I have other fish to fry at the moment.

I think the Buffet rule makes a lot of sense as a general guideline. Getting rid of the carried interest loophole and imposing a tax on high-speed trading would be two steps in the right direction IMHO.

Peter Donis said...

@Ron: "writing that blog post is on my to-do list"

Fair enough.

Don Geddis said...

Ron: "So Blodget was punished. Not so for the vast majority of subprime fraudsters."

Sure, but that was a single high-profile case. Which happened to have a smoking gun of dated, internal emails. And was still a difficult prosecution: no jail time. What fraction of 90's stock analysts received any punishment?

I haven't done the research on subprime bond raters. You seem to start with the assumption that anyone who rated the top tranche of an MBS as AAA was necessarily committing fraud, which I categorically reject. To get punishment, you need legally admittable evidence of a crime (perhaps that a particular analyst made a public recommendation that they didn't believe themselves, although even that might be more of an ethical violation than a criminal one). And were there really no prosecutions at all? There certainly seem to have been numerous (civil) legal actions, although presumably you are looking for criminal penalties. Although you haven't expressed just what law you think was broken. You just think people suffered, so you want someone to pay, I guess. Like the mob reasoning during a lynching?

Don Geddis said...

Ron: "I regularly get invited to meet with senators and congresscritters"

Absolutely, they have a need for fundraising, so you can exchange money for their time. That's part of their job (at least, the campaigning part): to sell contact and face time in exchange for donations.

You may think it's obvious, but the next step is far less clear (in my opinion) than you seem to be assuming: how does government power subsequently get exerted on your personal behalf, as a consequence of such fundraising? What I'm disputing, is whether campaign donations have significant influence over future policy.

(I.e., there is correlation, but the causation may run the other way. First, the politician decides how to vote on an issue -- perhaps by reading polls about what "the people" want. After, they accept donations from whatever rich people happen to be on the same side as their decision. The fact that the vote is in the direction that the donors want, does not mean that the donations caused the vote.)

Ron said...

> You may think it's obvious, but the next step is far less clear (in my opinion) than you seem to be assuming: how does government power subsequently get exerted on your personal behalf, as a consequence of such fundraising? What I'm disputing, is whether campaign donations have significant influence over future policy.

It's not just about policy. Legislators have a lot of influence besides their votes. If I can have a senator (or even one his staffers) make a phone call on my behalf I can get significant benefit from that.

But legislators have to make their decisions based on *something*. If that "something" includes the input that they get from what they read and hear, then if you do the math you will see that they cannot possibly talk directly to everyone. So just the opportunity to have a face-to-face conversation with a legislator gives you disproportionate influence. And having a face-to-face conversation where they know you're a donor and so are in a position to influence their odds of getting re-elected, even by a little bit, makes it more likely that they'll actually listen to what you have to say. So it's not like I can just call a senator and order him to vote one way or another, but in a situation where a legislator in on the fence about something I might be able to push him or her one way or the other more effectively than someone who isn't writing checks. Finally, I'm not a particularly deep pocket. If I were writing really big checks I might actually be able to exert quite a lot of influence by credibly threatening to finance a legislator's opponent in the next election.

Ron said...

@Don:

Just for the record"

> I haven't done the research on subprime bond raters. You seem to start with the assumption that anyone who rated the top tranche of an MBS as AAA was necessarily committing fraud, which I categorically reject.

No, I don't assume they were *all* committing fraud. But the evidence of widespread fraud is pretty overwhelming.

You should read this:

http://robertreich.org/post/137109198285

Don Geddis said...

Thanks, Ron. OK, I followed your link and read Reich's article. He offers zero "evidence of widespread fraud", in that article, much less overwhelming evidence.

I understand how you might find Reich's article compelling. But I'm surprised you think it would be convincing to someone who disagrees. Reich is writing a piece of political propaganda, in an attempt to influence policy outcomes. That doesn't mean his position is right or wrong, but it does mean that the article itself doesn't help one decide where the truth lies.

Just as an example of some areas where I disagree: "how the big banks screwed millions of Americans out of their homes, savings, and jobs" I still don't understand how offering poor-credit borrowers subprime mortgages, "screws" regular folks "out of" homes, savings, and jobs. If anything, it seems to be offering more mortgages than would have existed otherwise! I need the dots connected for me.

"and then got bailed out by taxpayers." I'm totally opposed to the bailouts. But none of the rest follows from that one area of agreement.

"reinstate the Glass-Steagall Act (separating investment from commercial banking)" This had no impact on the recession. If anything, the ability of financial institutions to become diverse, allow the industry to be stronger: a strong (commercial) bank could purchase a distressed (investment) bank -- or vis versa -- which offered more paths to recovery. There were essentially zero examples in the recession of some problem where a diverse investment/commercial financial firm got in trouble with a healthy (commercial?) side and a distressed (investment?) side, and that somehow caused problems for the economy. This is a bad solution to a non-problem.

"and then sold them to unwary investors" "Unwary investors"?!? Are you kidding me? MBSes were not purchased by the average retail grandmother, saving for their retirement. The investment banks sold them to institutional investors: pension funds, college endowment funds, etc. The purchasers were "sophisticated" investors, not "unwary" investors.

"It was a fraudulent Ponzi scheme that had to end badly" No, it was not a Ponzi scheme. There is no necessity that the MBSes needed to lose so much value. The mortgages were loans that (mostly) could have been paid off by the original borrowers ... had the real estate asset market not crashed so far, across the entire economy, simultaneously.

"innocent victims of misguided government policies" The government has tremendous intervention in the mortgage market. Freddie and Fannie Mae purchase and guarantee mortgages. Income tax law allows deductions for mortgage interest. Government policies and regulations all strongly encourage non-profitable lending to historically oppressed and struggling populations (ethnic, economic, geographic). All of these are justified by good intentions, but the authors of those interventions rarely appreciate all the unintended consequences. The idea that mortgage are a wild free market is simply false.

"we face substantial risk of another near-meltdown" No, that would only be true if the subprime lending ("necessarily") caused the subsequent recession. But the recession was caused by the central bank's tight monetary policy, not by the mortgage lending. So, whether the financial industry continues, or changes behavior, that has no consequence for a future recession.

Reich has his perspective. But he's offering opinion, not evidence.

Ron said...

What would you accept as evidence then? How about this:

http://www.npr.org/sections/thetwo-way/2016/01/14/463107541/goldman-sachs-will-pay-5-billion-to-settle-financial-crisis-claims

or this:

http://www.huffingtonpost.com/2013/02/11/wall-street-email_n_2624850.html

or this:

http://www.huffingtonpost.com/2013/02/05/sp-lawsuit-emails_n_2623933.html

or this:

http://www.pbs.org/wgbh/frontline/film/untouchables/

or this:

http://www.rollingstone.com/politics/news/wall-streets-naked-swindle-20100405

or this:

http://www.nybooks.com/articles/2014/01/09/financial-crisis-why-no-executive-prosecutions/

And that's just what I was able to find in five minutes of searching.

One choice quote from the last link:

"As the commission found, the signs of fraud were everywhere to be seen, with the number of reports of suspected mortgage fraud rising twenty-fold between 1996 and 2005 and then doubling again in the next four years."

Seriously, saying there is no evidence of fraud in the 2008 financial crisis is like saying there is no evidence for evolution.

Publius said...

Wow, 9 damming emails! Out of what, trillions of emails sent in the years before the crisis?

Did you ever research why there were only 3 credit rating agencies? Large institutional investors also have large treasurery and finance departments -- why weren't they doing their due diligence on these deals?

Oh, and what of those physics, engineering, and math boffins who went to work as quants? Did they not understand that mathematical models have limitations? Just because you can compute a number doesn't make it useful? Or that not everything (like, say, risk) can be represented with one variable?

The Goldman Sachs lawsuit was based on the federal governments prosecutorial theory of "they have money, let's take it from them."

No mention of Fannie Mae? What was the Fed doing to the money supply? Just why were so many subprime mortgages being written?

This article in the WSJ provides a more complete - and complex - explanation of the crisis:
http://www.wsj.com/articles/SB10001424052748704698004576104500524998280
It lists 10 causes. Lots of blame to go around.

That isn't helpful to politicians, though. They need someone to blame. Journalists especially hate banks - so they push the narrative of the greedy Wall Street bankers swindling the entire world. Politicians of both parties jump on this while simultaneously putting out their hands for campaign donations and bribes from those very same Wall Street firms.

Ron said...

> The Goldman Sachs lawsuit

The lawsuit is not the evidence. The fact that they agreed to settle is the evidence. If there were no evidence showing Goldman to be guilty, why would they settle? $5B is real money, even for Goldman.

> No mention of Fannie Mae?

http://robertreich.org/post/137109198285

"They want us to believe the banks and investment houses were innocent victims of misguided government policies that gave mortgages to poor people who shouldn’t have got them.


That’s pure baloney. The boom in subprime mortgages was concentrated in the private market, not in government. ... The fact is, more than 84 percent of the subprime mortgages in 2006 were issued by private institutions"

> This article in the WSJ

"We agree with our colleagues that individuals across the financial sector pursued their self-interest first, sometimes to the detriment of borrowers, investors, taxpayers and even their own firms."

That's about as close as the WSJ is ever going to get to admitting that there was fraud.

> 10 causes. Lots of blame to go around.

Sure. But as a response to allegations of fraud that is tantamount to saying, "Oh look, a kitten!" Just because fraud was not the only cause does not change the fact that fraud was a significant contributing factor.

DJ Penton said...

Well written, well argued, Ron. I am always surprised at how civilized you keep the tone. My convictions on this are similar to yours. And to think I got to know about you because of CL.

Ron said...

@DJ: Thank you for the kind words. I've tried to keep a civilized tone here since I started writing RR nearly thirteen years ago. I'm glad someone noticed.