TFTF

The Worst Ten-Letter Word

February 23, 2014

“Inequality has emerged as a major issue in the US and beyond. A generation ago it could reasonably have been asserted that the overall growth rate of the economy was the main influence on the growth in middle-class incomes and progress in reducing poverty. This is no longer a plausible claim.

“The share of income going to the top 1 per cent of earners has increased sharply. A rising share of output is going to profits. Real wages are stagnant. Family incomes have not risen as fast as productivity. The cumulative effect of all these developments is that the US may well be on the way to becoming a Downton Abbey economy. It is very likely that these issues will be with us long after the cyclical conditions have normalized and budget deficits have at last been addressed.”

– Lawrence Summers (in the Financial Times)

“Cyberpunk is a postmodern science fiction genre noted for its focus on ‘high tech and low life.’ It features advanced science, such as information technology and cybernetics, coupled with a degree of breakdown or radical change in the social order. ‘Classic cyberpunk characters were marginalized, alienated loners who lived on the edge of society in generally dystopic futures where daily life was impacted by rapid technological change, an ubiquitous datasphere of computerized information, and invasive modification of the human body.’”

– Lawrence Person (Wikipedia)

A new word is achieving ubiquity. The word has always been with us and at times has been a beacon to attract the friends of liberty and opportunity. But now I’m afraid it is beginning to be used as a justification for social and economic policies that will limit the expansion of both liberty and opportunity. The word? Inequality. More specifically, the word has become problematic when used in close proximity to the word income. There are those who believe that income inequality is the proximate cause of the Great Recession, if not the imminent demise of Western Civilization, pushing us into a dystopian world that will come to resemble the one depicted in the movie Blade Runner.

(Note: Blade Runner exemplifies a genre of science fiction called cyberpunk, defined above.)

This week we begin what will probably be a multi-week series on the subject of income inequality. Over the years, I’ve written many times about the lack of income growth for the middle class in the developed world. We have also looked at the growing spread between the top 1% or 5% or 10% and those further down the income scale. The widening spread is an undeniable fact. But what should be done about it? Do we take money from the more well-off, or do we increase opportunities for all? How do we increase opportunity without social expenditures for education and healthcare, and where will the money come from? What trade-offs do we get for the lost productivity and reduced savings that result from increased taxes? What institutional and policy barriers are there? These are all fundamentally important questions.

What spurred me to start this series was a recent paper from two economists (one from the St. Louis Federal Reserve) who are utterly remarkable in their ability to combine more bad economic ideas and research techniques into one paper than anyone in recent memory. Their even more remarkable conclusion is that income inequality was the cause of the Great Recession and subsequent lackluster growth. “Redistributive tax policy” is suggested approvingly. If direct redistribution is not politically possible, then other methods should be tried, the authors say.

So what is this notorious document? It’s “Inequality, the Great Recession, and Slow Recovery,” by Barry Z. Cynamon and Steven M. Fazzari. One could ask whether this is not just another bad economic paper among many. If so, why should we waste our time on it? And this week we’re actually not going to lay the paper out on the slab and dissect it; we’re just going to prepare for the post-mortem by getting up to speed on the issues it tries to address.

The problem is that the subject of income inequality has now permeated the national dialogue not just in the United States but throughout the entire developed world. It will shape the coming political contests in the United States. How we describe income inequality and determine its proximate causes will define the boundaries of future economic and social policy. In discussing the multiple problems with the paper, we have the opportunity to think about how we should actually address income inequality. And hopefully we’ll steer away from simplistic answers that conveniently mesh with our political biases.

I am pretty certain that by the end of the series I will have been able to offend nearly every reader, and some of you multiply. That’s OK – it means we’re thinking outside our boxes. I will admit to having been forced, of late, to change some of my more reflexively conservative positions with regard to the structural causes of income distribution trends and, even more importantly, the distribution of opportunity. It is the latter concept that should command our particular attention, and a fair distribution of opportunity should appeal to both libertarians (I more or less think of myself as one) and progressives.

The unfair distribution of opportunity is not an injustice that can be redressed simply by composing erudite paeans to free markets or social justice, even though politicians will try. The problem is far more complex than that. Are we in fact, as Larry Summers suggests, on the road to a Downton Abbey economy – or, even worse, a Blade Runner-like dystopia?

I should note that Professor Summers’ op-ed is a not entirely uneven discussion of the problem. “Given the widespread frustration with stagnant incomes, and an increasing body of evidence suggesting that the worst-off have few opportunities to improve their lot, demands for action are hardly unreasonable. The challenge is knowing what to do.” We will address Summers’ conclusions later in this series, but for now let’s think about how to approach the challenge of income inequality.

A quick search for the word inequality in Google Trends reveals that the general public is starting to take a lot more interest in the concept. Monthly searches for the word inequality have more than doubled in the past year or so. (Odd trivia fact: Indiana is the state with the highest search interest in inequality, ahead of college liberal Massachusetts.)

Of the underlying or related searches, income inequality is the most frequently searched term. It spiked to all-time highs after President Obama’s State of the Union address in January.

We have to take this data with a grain of salt, but it clearly shows that inequality is becoming a more popular search term. And if it is becoming a more popular search, that is clearly because people are thinking and talking about it a lot more. And if people are thinking and talking about the subject of income inequality a lot more, then my readers, who are by and large thought leaders in their respective worlds, have a serious responsbility to inform that discussion.

The fact that incomes of various segments of our society are diverging is not really disputable. There are many ways to sort for the reasons for income differentials, but one of the ways is by education level, where the income differences have become rather stark over the last 40 years. Note in the chart below that incomes for all segments of the population generally rose in tandem up until the beginning of the Information Age in the early ’70s, and then the disparity began to grow. Those with more education saw their incomes increase while those with less education saw their incomes fall.

As Summers noted, a rising share of GDP is going to profits as opposed to wages. This is a trend that started at the beginning of the last decade.

One other odd bit of information that I came across while researching this topic is that between 1979 and 2002 the frequency of long work hours (more than 50 hours a week) increased by 14.4 percent among the top quintile of wage earners but fell by 6.7 percent for the lowest quintile. And those extra hours translate into extra income. (You can see the NBER study here.) I don’t know about you, but my hours have significantly increased since 2002. Not sure that is relevant, but just saying.

Robber Barons

Let’s take a somewhat philosophical and less databased approach to income inequality. Mainstream economists and policy makers are still thinking of inequality through the lens of 19th and early 20th century experience, when robber barons like Carnegie, Rockefeller, and Vanderbilt supposedly lined their pockets by withholding reasonable wages from the working poor.

This is precisely what Larry Summers was getting at in this week’s Financial Times op-ed:

The share of income going to the top 1 percent of earners has increased sharply. A rising share of output is going to profits. Real wages are stagnant. Family incomes have not risen as fast as productivity. The cumulative effect of all these developments is that the US may well be on the way to becoming a Downton Abbey economy.

That thinking assumes that if income inequality is rising, the top 1% is getting richer at the expense of the working class, because it assumes production still heavily exploits the relatively unskilled labor that most Americans can provide through hard work. It does not discriminate between value-added labor and value-added information and innovation.

As I argued three weeks ago, the gains from the Information Age have been unevenly distributed throughout the economy. This is a structural problem in the sense that the productivity gains from the first two Industrial Revolutions are essentially thoroughly distributed through the economy. All workers saw their incomes increase along with increasing productivity for the 200 years of the Industrial Revolutions. Yes, entrepreneurs, innovators, and knowledge workers saw their incomes rise faster, but a rising tide of productivity lifted all boats.

The same phenomenon is playing out now in developing markets, where much of the basic infrastructure of industrial revolution is still being built. I would expect that the same income inequality issues would develop in those markets in conjunction with the full rollout of industrial revolution and the shift to a knowledge-based economy.

Another observation that I did not make three weeks ago but have subsequently come to embrace is that knowledge workers have indeed seen their incomes increase because of their ability to put their knowledge to work more productively. Goods-producing workers have by and large not seen much rising productivity in the last 30 years due solely to their work and thus have not seen an increase in their incomes. To the extent that workers have skills, their incomes rise.

(Please. I get that it is more complicated than this. Increased foreign competition for lower-skilled jobs and the bursting of two major bubbles have also put a dent in US incomes.)

That being said, the top 1% is getting richer either by (1) allocating capital to the right places (which all right-thinking people want to see happen), or (2) by employing skills that most of the American work force does not have – because production increasingly depends on the hard work of creative workers with hard-earned skills gained through education and experience.

Today, a much smaller percentage of our labor force is responsible for a much greater percentage of economic output. Their wages are rising because their productivity is rising.

The trouble with conventional wisdom about income inequality is that it is so fails to factor in productivity and the sources of productivity.

While populist politicians, mainstream economists, and envious market watchers would like to brand billionaire inventors like Tesla CEO and PayPal Founder Elon Musk, Facebook CEO Mark Zuckerberg, or eBay cofounder Pierre Omidyar as modern-day robber barons, they haven’t really robbed anyone. The emerging class of billionaires is creating value that did not exist before they arrived, and they’re doing it with relatively small teams of highly skilled knowledge workers. And they deserve every penny they earn.

On the flip side, a growing majority of our labor force is responsible for a much smaller percentage of economic output. Their wages are stagnant because more people are competing for a shrinking number of jobs.

The World’s First Trillionaire

I have brought to your attention before a very important book by Mark Buchanan called Ubiquity, Why Catastrophes Happen. I HIGHLY recommend it to those of you who, like me, are trying to understand the complexity of the markets. It’s not directly about investing, although he touches on that subject. Rather, it’s about chaos theory, complexity theory, and critical states. It is written in a manner any thoughtful layman can understand. There are no equations, just easy-to-grasp, well-written stories and analogies.

Buchanan talks about power laws and critical states. He wraps up his opening chapter like this:

There are many subtleties and twists in the story ... but the basic message, roughly speaking, is simple: The peculiar and exceptionally unstable organization of the critical state does indeed seem to be ubiquitous in our world. Researchers in the past few years have found its mathematical fingerprints in the workings of all the upheavals I've mentioned so far [earthquakes, eco-disasters, market crashes], as well as in the spreading of epidemics, the flaring of traffic jams, the patterns by which instructions trickle down from managers to workers in the office, and in many other things. At the heart of our story, then, lies the discovery that networks of things of all kinds – atoms, molecules, species, people, and even ideas – have a marked tendency to organize themselves along similar lines. On the basis of this insight, scientists are finally beginning to fathom what lies behind tumultuous events of all sorts, and to see patterns at work where they have never seen them before.

Now, let's think about this for a moment. I’ve written about the sand pile game where researchers created a computer simulation of the sand piles that we built as kids at the beach. In their simulation of the sand pile, they found that as the number of grains of sand involved in an avalanche doubled, the likelihood of an avalanche was reduced by 2.14 times. We find something similar with earthquakes. In terms of energy, the data indicate that earthquakes become four times less likely each time the energy they release is doubled. Mathematicians refer to this as a “power law,” a special mathematical pattern that stands out in contrast to the overall complexity of the earthquake process.

As I noted a few weeks ago in Outside the Box, we are indisputably living through the greatest era in human history. Humanity is immeasurably richer than it was 100 or 50 or even 20 years ago. And along with everyone getting richer, we’ve seen a rising number of super-rich. But as the Huffington Post noted a few weeks ago, even the super-rich are getting left behind by the uber-rich.

Eighty-five people have as much money as do the poorest 3.5 billion. The top 1% have almost half the liquid wealth that has been accumulated in the world. There are 1,426 known billionaires, and gods know how many additional kleptocrats and people who have managed to maintain some semblance of privacy.

I’ll bet you a great dinner at your favorite restaurant that the distribution of the world’s wealth very clearly follows a power law similar to the one that describes the distribution of earthquakes and other phenomena. (There is an economics paper in there somewhere. Send it to me when you’ve written it!)

Thought experiment: if world GDP grows at 3% compounded for the next 100 years, world gross domestic product will be 16 times greater than it is today. That’s simple math. But if the future is anything like the past, the distribution of that enormous increase will not be even throughout the population. Not everybody will be 16 times richer, and some people will be fabulously richer. Unbelievably richer. Off-the-charts and mind-bendingly richer.

Someday, and with the real possibility of its happening in our lifetimes, we will see the world’s first trillionaire. This week we awakened to the fascinating story of WhatsApp cofounder Jan Koum selling his company to yet another of the elitist uber-rich, Mark Zuckerberg, founder of Facebook. Theoretically, the 37-year-old Koum walks away with about $6.9 billion – after starting out as a refugee from Kiev some 20 years ago, living on food stamps. He created this fabulous wealth with a partner and less than 70 employees in just a few years on the strength of an idea, a lot of chutzpah, and venture capital from the very firm that Zuckerberg spurned less than 10 years ago (Sequoia Capital – and that in itself is a great side story you can learn about on Google).

Of course that is not yet $1 trillion, but that is not how we get to the world’s first trillionaire. Many of the young men and women who are billionaires today are going to be living to the end of this century. What if a few of them are able to compound their wealth at 6%, 8%, or even 10% a year? Below is a chart of what Jan Koum might see his wealth become if he were inclined to continue the chase.

Zoum has almost as much net worth today as Elon Musk, founder of PayPal and Tesla Motors ($10 billion). As noted above, there may be as many as 2,000 billionaires in the world, with more being created every day. I can think of half a dozen ideas that could generate more than $10 billion for their creators. A cure for cancer could easily be worth $100 billion. A new, clean, localized energy source could create multiples of that. There are already five family groups with over $50 billion each. At 6% compound returns they could top $1 trillion within 50 years, although several are giving away most of their wealth.

The point? It is not a matter of whether someone will be worth $1 trillion or whether they even deserve it. It is simply going to happen at some point. Quite frankly, I don’t care. I hope they take their capital and put it to productive uses that make the world richer and a better place to live while they themselves are getting fabulously rich. As long as they do it on an even playing field, “good on them.”

Income inequality is not going away. Visually, and given the realities of the unfolding Age of Transformation, we may even see greater disparities.

I do agree with Summers on one point: “It is very likely that these issues will be with us long after the cyclical conditions have normalized and budget deficits have at last been addressed.”

What else can we expect as long as we continue to rely on a 20th century education system to equip 21st century workers? When we allow crony capitalism to create an unequal playing field with special benefits for some? When businesses successfully lobby to create barriers to entry for future competition so that they can maintain their profits without having to compete? When we give tax benefits that help a relative few so that we are forced to tax those who are productive at ever higher rates?

Instead of obsessing over the rising income inequality that has always accompanied great periods of innovation (it took decades for the first and second Industrial Revolutions to be reflected in productivity numbers as well as overall wages), Larry Summers, Paul Krugman, and other “big league” mainstream economists should be advising President Obama, the House, the Senate, and every voter who will listen about the importance of aggressive reforms in education, entitlements, and tax/regulatory policy.

They should be asking why knowledge workers are moving ahead, while more of the labor force is left behind. And they should be formulating policies that can empower and encourage more unskilled workers (or workers with outdated skills) to become highly skilled knowledge workers in the coming decades. But such questions don’t suit their political agendas. These are not questions with easy answers. They demand hard work not only on the part of politicians, but also from the people wanting the benefits. The Age of Transformation will require constant education and updating of skills.

There is no way for a government to protect its citizens from increasingly accelerating change without ultimately destroying the benefits delivered by that change. The focus has to become on how to help people adapt and prosper in an environment of unremitting change. What sort of government and what economic policies will foster an environment that increases productivity and income for everyone?

Next week we will in fact get to the actual economic paper which kick-started me into this line of thinking, and we’ll also look at a remarkable study which shows that income mobility in the United States is still roughly where it was 40 years ago. As I will point out, that’s not good enough. Many countries (such as Denmark) do much better, and perhaps we should learn why and how. We will learn that trying to stimulate demand may not be the best monetary policy, and in fact it may be producing the actual environment in which income inequality is increasing. Ideas have consequences, and bad ideas typically have bad consequences. But all that’s for next week.

Houston, Los Angeles, Miami, Washington DC, Argentina, South Africa, San Diego, Brussels, and Geneva

I'm enjoying my longer than usual respite from travel, but tomorrow I will see my schedule pick up aggressively. I will be in Houston tomorrow night, then back home for a day before I go to Los Angeles, then fly cross-country to Miami for a speech for my friend and partner Darrell Cain. Then we’ll enjoy a fabulous Saturday evening soirée on the beach, when Patrick Cox, editor of Transformational Technology Alert, will come over from the West Coast of Florida for the evening to join us.

From Miami I will head to Washington DC for a few days of meetings. Then it's back home for almost two weeks before I head to Argentina for a few weeks. (Those of you interested in learning more about what's going on in Argentina and at La Estancia de Cafayate, where I'll be spending close to two weeks in the second half of March, might enjoy an article David Galland recently penned (he is such a beautiful writer), entitled “Argentine Diary: A Day in the Life on the Front Lines of a Crisis.”

From Argentina I’ll fly more or less directly to South Africa for a week. I’ll spend the first few days at a game resort and then jump into a speaking tour that will take me to Cape Town, Durban, and Johannesburg at the behest of Glacier by Sanlam, a very-full-service financial firm. I am looking forward to that trip.

After that, I am home for a little over two weeks before I head out to Brussels and Geneva (and perhaps another European city or two) and then head back home to prepare for my Strategic Investment Conference in San Diego, May 13-16. This is a fabulous conference, and you really should make plans to attend.

One of the people I will be meeting in DC is my old friend George Gilder. I was talking to him yesterday about schedules, and he noted that he came really close to not being able to … stay on schedule. It seems he was involved the day before in a head-on collision that totally destroyed both cars, but everyone in the cars walked away due to air bags and the marvelous collapsing design of recent-vintage cars. I am grateful for that new technology, because we need minds like George Gilder around for a lot longer to help us think about how to deal with the age of accelerating change. Not to mention that I would miss him personally. DC is shaping up to be an interesting few days, and I will report back to you.

It is time to hit the send button. I really do have to get a better handle on the timing of my trips. I will be leaving Dallas when the weather is perfect but have nothing scheduled for August when 100° days are typical. But then that is why God invented air conditioning. Have a great week!

Your wondering how his kids will adapt analyst,

John Mauldin

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sheldonlebowitz@gmail.com

Feb. 24, 2014, 9:03 a.m.

John,
For most of my life, from WWII till now, I have been hearing about “The Peace Dividend”.  After reading today’s New York Times I can see the light at the end of the tunnel.
President Obama is ending our wars and making it possible for people who need medical treatment to get it at affordable prices.
I believe that by the end of this century, President Obama will go down as one of our greatest Presidents.

barrond@silverleafresorts.com

Feb. 24, 2014, 7:27 a.m.

Thank you for discussing this topic.  I was first introduce to this topic by a youtube video “Wealth Inequality in America” (See url:  http://youtu.be/QPKKQnijnsM ) and has been viewed over 14 million times.

Richard P Taylor

Feb. 23, 2014, 10:44 p.m.

Nations, & the people who live in them, compete by providing products or services, that others want @ a price they are willing to pay. Nations with large public sectors(both as a % of GDP & from a regulatory/law standpoint) cannot compete as the impact to overhead costs makes them non-competitive in the long run…..unless they sell off natural resources to pay the bills….a short term solution.
The result has always led to reduction of middle class and the opportunities for the young & legal immigrants.
This brings about a super-rich small group, shrinking middle class and lots of poor.
Since the growth of the public sector(s) hasn’t improved the growth of middle class & opportunity….let’s try it the other way! Shrink the public sector!

William Hermann

Feb. 23, 2014, 9:59 p.m.

The concept of income inequality is only a predictable outcome from the complexity that has gripped our lives and the dwindling number of individuals with ability to understand and economically exploit new technology.  The harder it becomes the fewer people are capable.  Survival of the practical, not academic, intellectually fittest is the new iteration of a very old principal.

The answer to closing that inequality is to produce a much larger percent of the population able to leverage their skills to meet rapidly changing economic and technologic trends that require far from traditional approaches. 

So radical changes in the education of our youth, starting in “middle school”, is a necessity.  However, WHO is capable of making this radical change a reality AND bringing it from theory to broad practice.  That is truly modern society’s dilemma.

Traditional teachers and administrators are operating to a large part on automatic pilot using old metrics of traditional academic test performance and university placements to monitor success.  The results are predictably pretty good.  “Tradition” earns another year and continues while the real world gap as measured by that bottom-line metric called INCOME widens and everyone wonders why.

It is time for RADICAL change in the education system—individual student assessment of skills and KNOWLEDGEABLE, EFFECTIVE coaching by “counselors” and administrators firmly grounded in the real world must direct each student’s most EFFECTIVE path. With appropriate re-assessment in the formative years.

Where can we find such counselors and administrators enough to be present to the vast majority of US students in PUBLIC education….

I HAVE NO IDEA, BUT IT IS UNDENIABLY NEEDED AND THE SOLUTION TO THIS “PROBLEM”.  Also, make no mistake, human beings need personally identifiable incentives and to a very great extent income has long been such—- it must remain a differentiator and reward for properly and effectively navigating the career building process resulting in a profession/occupation that is truly loved as it is matched to personal talents.

Nick Proferes

Feb. 23, 2014, 9:12 p.m.

A very useful contribution to a very important and topical subject, especially with all the BS being circulated over raising the minimum wage from a paltry $7.25ph to a paltry $10 per hour.  I realize that minimum wage is only one small piece of this complex jigsaw puzzle but its a baseline for all the rest and needs serious discussion and resolution.

Skye Aureus

Feb. 23, 2014, 8:51 p.m.

Feb. 23, 2014
To: John Mauldin
wave@frontlinethoughts.com
From: Durk Pearson (MIT, 1965) & Sandy Shaw (UCLA, 1966)
email2sts@yahoo.com

Dear Mr. Mauldin,

    We are both great fans of your “Thoughts from the Frontline” and noticed your invitation to anyone who has written up an article on how the distribution of the world’s wealth follows a power law to send it to you pronto.  We are two scientists, coauthors of the #1 bestseller “Life Extension, a Practical Scientific Approach” (Warner Books, 1982) who write extensively on a variety of scientific as well as economic issues (see our free newsletter at www.life-enhancement.com; the website is the property of a company licensed to sell our dietary supplement formulations, but the newsletter is written entirely by ourselves and is not edited by Life Enhancement Products, Inc.).

    We have written an article (based upon economic experiments published in SCIENCE magazine—see reference below) on how the investment in avoiding harms to third parties decreases with increasing numbers of bidders in a market.  We disagree with the authors of the paper that this reflects a moral failure due to markets, and instead argue that it may take place as a result of a power law.  Although we realize that this doesn’t explain the economic distribution of the world’s wealth, perhaps it will interest you as an application of power laws to markets and economics.  We like your suggestion that somebody write up how power laws may explain something about income inequality and note that this is a nice open field just awaiting some original new ideas that needn’t come from professional economists or even somebody with a Ph.D. but just some creative thinkers intrigued by the potential for a world-changing view.

Negative Effect of Markets
on Moral Values

            OF MICE AND MEN AND MARKETS
                    by Durk Pearson & Sandy Shaw

    A new paper studied the effect of markets on moral values by setting up a moneymaking experiment in trade whereby it would cost people money to avoid harms to third parties.  The researchers found that the more the number of people involved in a market trade, the less money people would forego to avoid harms to third parties.  They concluded, therefore, that markets had a negative effect on moral principles.

    The experiment went like this:  a buyer and seller, each in possession of a mouse, could divide a sum of money and keep the proceeds. (The mouse was left over from an experiment and, in
the usual course of events, would be euthanized at that point, but for the sake of this experiment would be allowed to live if the owner of the mouse were willing to forego a certain amount of a sum of money (the price for allowing the mouse to live).)  The idea was to see what effect being in a moneymaking trade arrangement, a market, would have on the price people were willing to pay to allow the mouse to live. 

    The experimenters obviously considered it moral to be willing to forego some money to keep the mouse alive, but immoral to simply keep the money and let the mouse die.  (As part of the experiment, the participants watched a short movie of how a mouse would die, so nobody had any illusions. For the mouse, the outcome was a matter of life or death.)  We would have preferred it if the researchers had called the decision to keep a mouse alive a personal value rather than a matter of morality, as we do not agree that allowing a mouse to die is immoral.  (Such values are intensely subjective. In the Jaine moral system, for example, it would be considered immoral to kill even an ant.)

    In the individual decision option, Option A, a mouse would be allowed to live but the participant would receive no money.  Option B meant that the mouse would die but the participant would receive 10 euros.  There were 124 participants in the individual decision option, of which 45.9% were willing to allow the mouse to die in order to get 10 euros.  In the bilateral market (2 participants traded for prices), 72.2% of sellers were willing to let the mouse die for prices below or equal to 10 euros.  This difference was statistically significant from the individual decision option.  In the multilateral market (where there were 7 bidders), 75.9% of sellers were willing to kill a mouse for less than or equal to 10 euros.  This, too, was statistically significantly different from the individual decision option.

    The more bidders, the lower the average price offered in exchange for allowing the mouse to live.  (In a separate experiment, people could either keep and spend a coupon or take a certain amount of money.  The effects of numbers of bidders in this condition revealed no significant price trend.)  The authors conclude, therefore, that the market had the effect (and the larger the market, the greater the effect) of reducing the price paid for a moral outcome (allowing the mouse to live).

    The authors sum it up:  “We therefore agree with the statement quoted at the beginning that we as a society have to think about where markets are appropriate—and where they are not.”

   
    We offer the following comments:

                  POWER LAW

    The decreasing price paid as the number of bidders increases looks a lot like a power law, which is a characteristic of self-
organizing systems as described in the book UBIQUITY by Mark Buchanan (Three Rivers Press, 2000).  As explained in UBIQUITY, for example, if you look at a sandpile on which grains of sand are being dropped one by one, eventually at some point you will have an avalanche.  If you double the amount of energy released by the avalanche, the avalanche becomes four times less likely.  You see the same pattern with earthquakes: the larger the earthquake, the less likely that size event will occur, consistent with the mathematical power law you see with avalanches. 

    Thus, we propose that the higher the number of bidders in the market, the lower the price paid to avoid harms to third parties, is a power law, something that is mathematically built into markets as self-organizing systems.  It is not that people become less moral as the number of bidders increases; it is that the likelihood of the decision of each individual determining the average price becomes less and less as the number of bidders increases.

          POLITICAL DECISIONMAKING VS. MARKETS
    The researchers wonder, as indicated in their summation, whether under some circumstances decisions should be made by a different mechanism than markets.  Whether a political process would result in a more “moral” outcome than a market is we believe questionable.  The more voters, the less likely that your decision will affect the outcome of an election and, hence, the less likely that voters will concern themselves with harms to third parties.  Moreover, the less likely that your decision will decide the outcome of an election, the less likely you will have an incentive to be well informed before you vote, the “rational ignorance” problem.  The authors note that “it is a pervasive feature of market interaction to impose costs on uninvolved third parties.”  We agree.  Yet, there can be no doubt that the production of externalities (costs to uninvolved third parties) is a pervasive feature of political processes. 

    Moreover, there may be costs in the use of politics as a way of making decisions by large numbers of people that go beyond that of markets.  Even as the authors themselves noted, not all the participants chose to take part in the bidding of their experimental market(*).  In politics, you can refuse to vote but the outcome of the election (the decisions of other people) will be imposed upon you anyway, whereas refusing to enter the bidding in a market transaction allows you to opt out, at least in part, of the costs of whatever other people decide.  In the usual trade, opting out means you can keep your money and use it for something else.

(1) Falk and Szech, “Morals and Markets,” SCIENCE 340:707-711 (2013)
(*) “22.2% of all traders in the bilateral market never traded, while in the multilateral market, 24.1% never traded. ...27.1% of subjects [in the individual decision option] were unwilling to
kill their mouse even for the maximum offered monetary amount of 50 euros.”

 

Dallas Kennedy

Feb. 23, 2014, 8:41 p.m.

Income inequality has been growing in the US for more than 40 years, for several mutually reinforcing reasons. It is a cause of neither the Great Recession nor the slow recovery. The Great Recession was caused by a sudden stop in the high credit growth of the previous decade and a half, while the slow recovery is the result of the ongoing deleveraging of the resulting excessive debt. Serious economists and historians know this and, if they’re being honest, will say so publicly.

However, some of the policies forced on us over the last 20 years or so by those attempting to mitigate growing wealth inequality (which is related, but not the same) are directly implicated in the stock bubble of 1996-2000, the stock crash of 2000-2, the mortgage bubble of 2002-7, and the credit crisis of 2007-9. These policies are not cures of anything, but just rehashes of what got us to where we are in the first place. The centerpiece of these policies has been to entice lower income people into debts (especially mortgage and student debt) they cannot repay and enjoy the ride while they can freely borrow. These gambit is coming to an end.

Income inequality has three main causes: the gap between the college-educated and those without, the breakdown of the two-parent household norm, and the effects of automation (more important) and globalization (less important). The first and third strongly reinforce each other. Until the 90s, the working class (typically with no more than a high school education) could hold its own, even as the college-educated were moving ahead. After the 1991 recession, that was no longer the case. The second cause is powerful both in its static effect on household income (lowering the income per household) and its dynamic effect in reinforcing poor prospects for later generations, who are likely to repeat the behavior. Reinforcing it is “assortative mating,” which means doctors marry doctors and lawyers marry lawyers, rather than nurses and secretaries. These latter causes have contributed to the rise of a caste system in America, something many are still oblivious to, because it’s genuinely new.

Political action centered in Washington will not cure it, because Washington is emphatically part of the problem, not its solution. The Washington metro area now has the highest per capita income and per capiita wealth in the country. (You read that correctly.) Washington has become a true parasitic imperial center, the heart of a cronyistic plutocracy that is driven by public servants cashing in on public service in the private sector. The change in this direction in just the last five years has been stunning, but its roots go back 25 years, at least.

Inflation can’t reduce inequality either. While it hurts everyone, it hurts the least affluent the most, because they hold all their wealth in cash.

The generational angle cannot be neglected. The Millennial generation is starting its adult life in weak position, indebted, and with poor job prospects. Their parents, the Boomers, and their grandparents have reaped the large majority of the benefits of postwar economic growth, while the Millennials are paying the bill for most of the excess.

We know what reduces both poverty and income inequality: strong economic growth built on real fundamentals, including high capital investment. Most of our policies now are designed to discourage this and instead encourage speculative and other non-productive uses of capital, as well as dependency. A strong job market, pulling in many who are marginally attached to the labor force, is the key. The strongest reductions in inequality and poverty occurred in the 1960s, the late 1980s, and the late 1990s, all of which featured high real growth and tight labor markets.

While factors such as demographics are beyond the direct reach of public policy, public policy has had a real and destructive effect, contributing to the rise of income inequality. Any hope of reversing these policies means also a hope that real growth will pick up, the labor force will start growing again, and income inequality will shrink.

C W

Feb. 23, 2014, 7:27 p.m.

John,
I just want to tell you how much I have benefited from following your ideas these past few years.  This is my first comment. I appreciate what you do!

Now, as regards Front Line Thoughts for this week.  You are correct that great wealth will provide great benefits for society.  This will always be true as long as this wealth is invested or deployed correctly - as you yourself say.

What if great wealth is NOT deployed correctly, though?
Well, that’s where the authors of the paper with which you take issue may have a point that will have to be addressed, sooner or later.

Best of regards,
C

rtwight@fastmail.net

Feb. 23, 2014, 7:03 p.m.

John:  Excellent, thoughtful article.  And for your future take on this I refer you to the following article:  http://www.independent.org/newsroom/article.asp?id=4923

rrmudge@hotmail.com

Feb. 23, 2014, 6:14 p.m.

One simple, perhaps simplistic, way to increase opportunities for lower income people would be to modify the current affirmative action programs to give priority to people from lower income families.  The current system benefits some individuals from groups that have been discriminated against in the past, but are now successful.  Why not focus univeristy admissions and government contract preferences for individuals from lower income groups—say the bottom fifth.  I have mixed feelings about this since there is a strong economic case to hire the best,regardless of background and I can imagine difficult administrative issues with such a change, but if we are to have affirmative action, should it not focus on the problems of today.

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