Economics

An intriguing article by economists Peter Lindert and Jeffrey Williamson (based on their new book) traces the history of American income inequality. While some suggest that inequality is driven by a “fundamental law of capitalist development,” it turns out that “episodic shifts in five basic forces” to to blame: “demography, education policy, trade competition, financial regulation policy, and labour-saving technological change.” The following took me by surprise:

Colonial America was the most income-egalitarian rich place on the planet. Among all Americans – slaves included – the richest 1% got only 8.5% of total income in 1774. Among free Americans, the top 1% got only 7.6%. Today, the top 1% in the US gets more than 20% of total income. Colonial America looks even more egalitarian when the comparison is by region – in New England the income Gini co-efficient was 0.37, the Middle Atlantic was 0.38, and the free South 0.34. Today the US income Gini is more than 0.5, before taxes and transfers. Colonial America was also far less unequal than Western Europe. England and Wales in 1759 had an income Gini of 0.52,and in 1802 it was 0.59. Holland in 1732 had an income Gini of 0.61, and the Netherlands in 1909 had 0.56.  Also, if you agree with neo-institutionalists that economic equality fosters political equality, which fosters pro-growth policies and institutions, then America’s huge middle class is certainly consistent with the young republic’s pro-growth Hamiltonian stance from 1790 onwards. That is, the middle 40% of the distribution got fully 52.5% of total income in New England, the cradle of the revolution!

However, inequality began to rise between 1800 and 1860, “matching the widening income gaps we have witnessed since the 1970s. The earlier rise was not dominated by a surge in the property income share, as argued by Piketty (2014). Rather, this first great rise in inequality was broadly based, with widening income gaps throughout the whole income spectrum – rising urban-rural income gaps, skill premiums, gaps between slaves and the free, North-South income gaps, earnings inequality, and even property income inequality.”

Yet,

the income share captured by the richest 1% fell dramatically between the 1910s and the 1970s, and the share of the bottom half rose, for almost all countries supplying the necessary data. This ‘Great Levelling’ took place for several reasons. Wars and other macro-shocks destroyed private wealth (especially financial wealth) and shifted the political balance toward the left.  The labour force grew more slowly and automation was less rapid, improving the incomes of the less skilled. Rising trade barriers lowered the import of labour-intensive products and the export of skill-intensive products, favouring the less skilled in the lower and middle ranks. And in the US, the financial crash of 1929-1933 was followed by a half century of tight financial regulation, which held down the incomes of those employed in the financial sector and the net returns reaped by rich investors.

The authors note that “policies regarding education, financial regulation, and inheritance taxation…offer ways to check the rise of inequality while also promoting growth.” It is worth pointing out that this is about inequality and not about the absolute economic betterment of the average American. Nonetheless, understanding this economic history is important for those on both the right and the left.

In April, I wrote about a new 10-year experiment testing a universal basic income in Kenya. While I find arguments for UBI compelling (especially those made by Matt Zwolinski), it is worth looking what experts are saying about it. Charles Murray has argued that for the UBI to work, it must replace all other transfer systems and bureaucracies. But economists are not so sure.

Granted, this is mainly a response to Murray’s particular brand of UBI. But are there other reasons to be skeptical of UBI? Let’s consider the costs. The Economist reports,

An economy as rich as America’s could afford to pay citizens a basic income worth about $10,000 a year if it began collecting about as much tax as a share of GDP as Germany (35%, as opposed to the current 26%) and replaced all other welfare programmes (including Social Security, or pensions, but not including health care) with the basic-income payment.

Such a big jump in the size of the state should make anyone wary. Even if levied efficiently, on an immovable asset like land, tax rises on this scale would have unpredictable effects on growth and wealth creation. Yet an income of $10,000 is still extremely low: it would leave many poorer people, such as those who rely on the state pension, worse off than they are now—at the same time as billionaires started getting more money from the state.

A universal basic income would also destroy the conditionality on which modern welfare states are built. During an experiment with a basic-income-like programme in Manitoba, Canada, most people continued to work. But over time, the stigma against leaving the workforce would surely erode: large segments of society could drift into an alienated idleness. Tensions between those who continue to work and pay taxes and those opting out weaken the current system; under a basic income, they could rip the welfare state apart.

Lastly, a basic income would make it almost impossible for countries to have open borders. The right to an income would encourage rich-world governments either to shut the doors to immigrants, or to create second-class citizenries without access to state support.

The Brookings Institution’s Isabel Sawhill lists two major objections to a UBI:

1. “Robert Greenstein argues…that a UBI would actually hurt the poor by reallocating support up the income scale. His logic is inescapable: either we have to spend additional trillions providing income grants to all Americans or we have to limit assistance to those who need it most.”
2. “Liberals have been less willing to openly acknowledge that a little paternalism in social policy may not be such a bad thing. In fact, progressives and libertarians alike are loath to admit that many of the poor and jobless are lacking more than just cash. They may be addicted to drugs or alcohol, suffer from mental health issues, have criminal records, or have difficulty functioning in a complex society. Money may be needed but money by itself does not cure such ills.”

She instead suggests the possibility of “unconditional payments along the lines of a UBI, but to phase it out as income rises.” But more fundamentally, she notes that “the biggest problem with a universal basic income may not be its costs or its distributive implications, but the flawed assumption that money cures all ills.”

As we wrestle over the best policy to assist the poor and needy, we must be willing to look at it from all angles.

World Bank economist Harun Onder has a post over at the Brookings Institution on his brand new study on rising nationalism and older generations:

Much ink has been spilled against such premises of rising nationalism. But a curious observation remains to be explained: Why do nationalist arguments tend to resonate with old people? Take the recent case of Brexit. Only a quarter of youth (ages 18-24) voted for the “leave” camp. In comparison, six out of ten old people (ages 65+) wanted to leave. The youth were quick to announce the stark contrast in social media and clarify their position! So, what is it that the old know about globalization that the young fail to see?

In a recent study, my colleagues Richard Chisik and Dhimitri Qirjo and I tried to explain how demographic aging—an increase in the share of old people in the country—could shift the economic policy preferences in an economy. Because nationalist sentiments often involve objections to free trade and migration, we paid particular attention to those policies. We came up with three interesting results that may help us understand how aging and nationalism are linked.

These results include:

1. An aging population is more dependent on imports: “To see this, note that the old consume more services like long-term care and the young consume more goods like smartphones. Therefore, the higher the share of old people in the population, the higher the demand for services, which cannot be imported, and the lower the demand for goods that can be imported.”
2. When aging occurs, more firms move overseas if trade barriers are low: “If…the aging country imposes egregiously high tariffs on imports, smartphone producers might rethink their relocation decisions.”
3. Nationalists may have a point about free trade at first glance, but more in-depth analysis proves otherwise: “From the nationalist point of view, erecting barriers at the border, be it made of concrete or import tariffs, may appear to make sense economically. However, this logic is terribly shortsighted: It is based on a static view of a world where actions cause no reactions. More specifically, it fails to recognize that when one country erects barriers its partners will do the same in response. In the end, a trade war may be triggered, only to be accompanied by a rising wave of protectionism, which would hurt the aging country more than the partner.”

Check it out.

The Wall Street Journal reported on a new IMF study analyzing Piketty’s hypothesis “that income inequality has risen because returns on capital—such as profits, interest and rent that are more gleanings of the rich than the poor—outpaced economic growth.” IMF economist Carlos Góes

tested the thesis against three decades of data from 19 advanced economies. “I find no empirical evidence that dynamics move in the way Piketty suggests.” In fact, for three-quarters of the countries he studied, inequality actually fell when capital returns accelerated faster than output. Those findings support previous work by Daron Acemoglu of the Massachusetts Institute of Technology and political scientist James Robinson, now of the University of Chicago, suggesting Mr. Piketty’s thesis was far too simplistic for the complexities of real-world economies that are affected by politics and technology. Mr. Góes says his study also provides evidence that Mr. Piketty’s assumption that saving rates remain stable is flawed. Rather, the data shows changes in the savings rate are likely to offset most of the effects of an increase in capital share of national income.

I’ve written about the criticisms of Piketty before. They seem to be piling up.

I’ve mentioned the populist trade problem before. GMU economist Bryan Caplan has published on the irrationality of voters, demonstrating that voters tend to suffer from biases that disagree with the findings of actual economists. Given our current political climate, consider what he calls “anti-foreign bias”:

Harvard’s Greg Mankiw writes in The New York Times,

Voters clearly aren’t listening to economists. In a recent poll, an overwhelming number of leading economists agreed that Brexit would most likely lower incomes both in Britain and in the rest of the European Union.

Similarly, in the United States, most top economists agree that “past major trade deals have benefited most Americans” and that “trade with China makes most Americans better off.” But those aren’t sentiments we will be hearing anytime soon from Mr. Trump or Mrs. Clinton.

In one respect, it is easy to understand why. According to a CBS News/New York Times poll conducted last month, only 35 percent of registered voters thought the United States gained from globalization, while 55 percent thought it lost. On issues of international trade, the current crop of candidates is following public opinion. (Henceforth the president, rather than being our elected leader, may be called our elected follower.)

So why are voters so out of touch with the evidence? Mankiw explains,

In particular, Edward Mansfield and Diana Mutz, professors in the political science department of the University of Pennsylvania, have written a pair of research papers exploring attitudes toward free trade and offshore outsourcing. This work gives some clues about what may be happening inside the minds of today’s voters.

…In actuality…people’s attitudes about free trade and offshore outsourcing are unrelated to the characteristics of the industry in which they are employed. After analyzing their survey data on individuals’ attitudes and attributes, these political scientists conclude that voters embrace policies based on the broader national interest…The data analysis of Mr. Mansfield and Ms. Mutz suggests that skepticism about trade and outsourcing is closely related to three other sets of beliefs.

These beliefs are:

1. Isolationism: the belief that “the United States should stay out of world affairs and avoid getting involved in foreign conflicts. They are not eager for the United States to work with other nations to solve global problems like hunger and pollution.”
2. Nationalism: the belief that “the United States is culturally superior to other nations. They say the world would be better if people elsewhere were more like Americans.”
3. Ethnocentrism: the belief that the world is divided “into racial and ethnic groups and think that the one they belong to is better than the others. They say their own group is harder-working, less wasteful and more trustworthy.”

Mankiw concludes,

As Mr. Mansfield and Ms. Mutz put it, “trade preferences are driven less by economic considerations and more by an individual’s psychological worldview.” They also report that this isolationist, nationalist, ethnocentric worldview is related to one’s level of education. The more years of schooling people have, the more likely they are to reject anti-globalization attitudes…In the long run, therefore, there is reason for optimism. As society slowly becomes more educated from generation to generation, the general public’s attitudes toward globalization should move toward the experts’.

Let’s hope so.