Monday, February 17, 2014

Krugman vs. Mankiw

Paul Krugman, last spotted around these parts refuting his own arguments on income inequality, is upset with Harvard economics professor Greg Mankiw for penning a defense of the top 1 percent income earners in Sunday's New York Times (Krugman's own turf -- one could be forgiven for suspecting that a partial motivation for Mankiw's authoring of the piece was the joy of trolling Krugman). In his column Mankiw notes the huge sums earned by movie stars, top athletes, best-selling authors and the like, and speculates that the lack of public ire over such incomes is due to a sense by most people that the money was deserved as their talents are readily observable and obvious (e.g. Robert Downey Jr. was paid $50 million for Iron Man 3, but his acting ability also helped produce well over $1 billion in revenue for the movie). In sharp contrast, Mankiw speculates that anger over the compensation of CEOs and those who work on Wall Street may stem from their talents and the benefits they generate being much less apparent. 

In a Sunday morning blog post Krugman responded by managing to totally miss Mankiw's point:
Greg Mankiw has written another defense of the 0.1 percent — and this one is kind of amazing. 
Before I get to the amazing part, however, can I say enough with the movie stars. Yes, a handful of media stars make a lot of money. But they are a trivial part of the story (pdf): 
The upper tiers of the income distribution are overwhelmingly occupied by executives of one kind or another — corporate, finance, real estate, and lawyers who are surely more corporate than Perry Mason. And even the biggest names in media aren’t real players. Remember, the 40 top-paid hedge fund managers and traders made an average of more than $400 million each in 2012.
That's great, but Mankiw explicitly acknowledged in his column that entertainers and media types comprise a minority of top earners:
[A]ctors, authors, and athletes do not make up the entire ranks of the rich. Most top earners make their fortunes in ways that are less transparent to the public.
After raising a point irrelevant to Mankiw's column (whose argument depends not at all with how many people in the media, arts or sports are earning big bucks), Krugman then blasts the Harvard professor for advancing the idea that, given the important role of Wall Street in allocating the country's capital, "It makes sense that a nation would allocate many of its most talented and thus highly compensated individuals to the task." 
Has Greg been living in a cave since 2006? We’re now in the seventh year of a slump brought on by Wall Street excess; the wizardly job of “allocating the economy’s investment resouces [sic -- Krugman was evidently in such a rage and so eager to get the piece published that he didn't even run a spell check]” consisted, we now know, largely of funneling money into a real estate bubble, using fancy financial engineering to create the illusion of sound, safe investment. We also know that there is a real question whether hedge funds, in particular, actually destroy value for their investors.
Whatever one thinks of Krugman's ranting, a sophisticated argument (excess!) against the value of Wall Street it is not. Indeed, it is not at all apparent what exactly Krugman is getting at here. So, because of the financial crisis, then Mankiw is wrong that capital allocation is an important task which attracts very talented and richly compensated people? Also unaddressed by Krugman is Mankiw's point that "recent research establishes that those working in finance face particularly risky incomes. Greater risk requires greater reward."

In any case, if Krugman wanted to make a more sensible case against Mankiw he should have taken issue with his blanket description of Wall Street as "decentralized and competitive." As but one example, the credit ratings agencies which were at the heart of the real estate bubble and its aftermath are a regulated oligopoly, facing less competition that it would under a free market. But for Krugman to make this line of attack would have required being on the side of smaller government, and so his avoidance of it is unsurprising.

Mankiw, meanwhile, responded to Krugman's post on his own blog, via a link to his economics textbook, that a variety of players -- including government regulators -- were responsible for the crisis.

Lastly, Krugman concludes his blog post by discussing tax fairness:
One more thing: Mankiw argues that our tax system is fair because the top 0.1 percent pays a higher share of income in federal taxes than the middle class. This neglects the partial offset of this progressivity by regressive state and local taxes. But surely the main point is that to the extent that taxes on the 0.1 percent are high (they aren’t really, in historical context) that’s largely because Mitt Romney lost the 2012 election, so that Obama’s partial rollback of the Bush tax cuts and the high-income surcharges that partially finance health reform remained in place and the Ryan budget didn’t happen. It’s kind of funny to claim that our system is fair thanks to policies that you and your friends tried desperately to kill.
A few points:
  • Krugman is apparently unaware that even if Mitt Romney would have won in 2012 that Democrats still would have controlled the Senate, thus almost assuredly blocking the path for any tax reduction on top income brackets. 
  • Even if the Ryan budget -- or any other conceivable GOP budget plan -- had passed, the rich still would have paid much more in federal tax as a percentage of their income than the middle class. As Mankiw points out in his column (but Krugman declines to note), the top one-tenth of 1 percent of the income distribution paid 33.8% of their income in federal taxes while the middle class, defined as the middle fifth of the income distribution, paid 12.4% -- a 21.4 percentage point gap. Slash this by 10 percentage points (an extreme scenario) and the rich are still paying a good bit more than the middle class (also recall there is no tax cut plan in existence which only cuts taxes for the rich but not the middle class as well, further complicating the math). 
  • One can play these counterfactuals all day. It's not hard to imagine that had Al Gore prevailed in the 2000 election that the Clinton-era top tax rate of 39.6% would have been maintained for all of last decade -- but so what? If ifs and buts were candy and nuts...
Little wonder that Scott Winship labeled Krugman's blog post "one of the most disingenuous things I’ve read of his in awhile."

No comments: