Capitalism is such a smashing success that it has become increasingly difficult for its critics on the left to argue with a straight face that it impoverishes the poor or fails to generate growth among all segments of society. Rather, one of the criticisms most commonly leveled now is that it promotes income inequality. In reality, this is a non-problem. If I get a $10,000 raise and my boss gets a $30,000 raise, our inequality has increased even though we are both unquestionably better off. Thus, watching leftist critics attempt to explain why income inequality is a problem is high entertainment, as it inevitably produces strange twists of logic and various mental gymnastics.
The latest example of this comes courtesy of Steven Pearlstein, the Washington Post's business columnist whose musings on politics and economics have made him a frequent target of this blog:
Too much inequality can lead to financial bubbles.
The liberal version of this argument comes from former Labor secretary Robert Reich in his new book, "Aftershock." Because so much of the nation's income is siphoned off to the super-rich, Reich says, a struggling middle class trying to maintain its standard of living had no choice but to take on more and more debt. I have some problem with the argument that the middle class had no choice, but it's certainly true that the middle class and the economy as a whole would be in better shape today if households weren't burdened with so much debt.
The more conservative version of this argument comes from University of Chicago economist Raghuram Rajan. In his new book, "Fault Lines," Rajan argues that in order to respond to the stagnant incomes of their constituents, politicians took a number of steps to keep the "American Dream" within reach, including subsidization of home mortgages and college loans. He might have added that politicians also were quick to cut taxes for the middle class even when it meant running up the national debt to pay for popular entitlement programs and government services.
This is so tenuous and thinly argued one hardly knows how to respond. As for Reich's argument, the middle class hasn't had their income siphoned off to the rich. Indeed, total compensation has been increasing. Any struggles on their part have nothing to do with the fact that Bill Gates, Warren Buffet or any other wealthy individual has gotten rich. Although there is some evidence that wages have stagnated among some workers, this is typically due to increasing amounts of compensation going to health care costs, not some fat cat's wallet. If money is being taken to line someone else's pocket, it is that of the government, not the guy who employs you.
As for his use of Rajan's book, the increase in housing and higher education have nothing to do with income inequality. The cost of admission didn't suddenly jump because the upper 1% are bidding up prices for their kids to attend college or because they started buying up every property up and down the East and West Coasts. Indeed, the cost increase of both is best explained by poor public policy. The last sentence, meanwhile, is a non-sequitur.
Concentrating so much income in a relatively small number of households has also led to trillions of dollars being spent and invested in ways that were spectacularly unproductive. In recent decades, the rich have used their winnings to bid up the prices of artwork and fancy cars, the tuition at prestigious private schools and universities, the services of celebrity hairdressers and interior decorators, and real estate in fashionable enclaves from Park City to Park Avenue. And what wasn't misspent was largely misinvested in hedge funds and private equity vehicles that played a pivotal role in inflating a series of speculative financial bubbles, from the junk bond bubble of the '80s to the tech and telecom bubble of the '90s to the credit bubble of the past decade.
Let me get this straight: money was wasted because it was concentrated in the hands of the people who made it in the first place, who then turned into mindless dolts, blowing their wealth on art, fancy cars and celebrity hairdressers? That a significant factor behind the creation of financial bubbles is simply rich people who are too stupid to find productive ends for their wealth? Let's assume this is true: what on earth does this have to do with income inequality?
If someone is a fool with their money then they are a fool with their money. They don't spend their money foolishly simply because they have a lot more money than someone in the middle class. Furthermore, let's say that income inequality was much less pronounced and more of the nation's wealth found its way to those further down the ladder -- then what? Would the middle and lower classes have allocated the money to more productive ends? If he believes that, then he must be unaware of the millions upon millions of middle class people who engaged in real estate speculation over the last decade.
The biggest problem with runaway inequality, however, is that it undermines the unity of purpose necessary for any firm, or any nation, to thrive. People don't work hard, take risks and make sacrifices if they think the rewards will all flow to others. Conservative Republicans use this argument all the time in trying to justify lower tax rates for wealthy earners and investors, but they chose to ignore it when it comes to the incomes of everyone else.
I don't even know what the first sentence means. What is our unity of purpose? Why must we have one? Why can't we each do what makes us happy? His second sentence is correct -- people won't take risks when they think the rewards will flow to others, namely the IRS. I fail to see, however, how this applies to the private sector. Are productive people being robbed by the rich? Is Bill Gates a stick-up artist? If someone is productive and not being compensated they can simply move to another company. McKinsey didn't write a study on the "war for talent" for nothing. Honestly, what on earth is Pearlstein talking about?
It's no coincidence that polarization of income distribution in the United States coincides with a polarization of the political process. Just as income inequality has eroded any sense that we are all in this together, it has also eroded the political consensus necessary for effective government. There can be no better proof of that proposition than the current election cycle, in which the last of the moderates are being driven from the political process and the most likely prospect is for years of ideological warfare and political gridlock.
That's true, we aren't all in this together, with 47 percent of all households failing to pay any federal income tax due in large part to various loopholes and deductions dispensed by politicians. A small minority is funding the welfare state that redistributes this wealth. Linking political polarization to income inequality, meanwhile, is nonsensical. The dividing lines aren't found over income inequality, it's about a debate over the role of government. Indeed, many of those on the lower end of the income spectrum are firmly opposed to the policies being proffered by those such as Pearlstein to address this alleged problem.
Political candidates may not be talking about income inequality during this election, but it is the unspoken issue that underlies all the others. Without a sense of shared prosperity, there can be no prosperity. And given the realities of global capitalism, with its booms and busts and winner-take-all dynamic, that will require more government involvement in the economy, not less.
Winner take all? Really? I guess that is why there is only one TV manufacturer, one car manufacturer, one plumbing company per town, one restaurant, etc. etc. Perhaps this can be excused as a rhetorical flourish. Even so, the only thing correct here is that general prosperity is good. But general prosperity and income inequality are not incompatible, as we can all simply prosper at different rates. If history is any guide, meanwhile, prosperity is to be found in limited government, not its expansion.
Related: See this Mark Perry post which wonders whether income inequality has been exaggerated in the first place, and this one on income inequality in the NFL.
Update: Diana Furchtgott-Roth has some thoughts on inequality.
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