Income Disparity and the Occupy Wall St. Crowd.

I've posted before about the income gap in this country.  Alas, I have to acknowledge I made a prediction that ultimately turned out to be wrong that the economic downturn would shrink the gap.  Well, as they say, predicting is hard, especially about the future, but even if I can't predict the future well, I stand by my overall points of what we should make of the income gap itself.

Anyhow, income inequality is back in the news with the Occupy Wall Street (OWS) protesters making a big deal of it.  It's certainly a real issue (albeit, as I've said before, a symptom of underlying problems rather than a direct problem itself).  But I think the OWS folks both make the mistake of viewing it as the problem, but also making assumptions about the causes that imply fixes that would not be appropriate.

At a macro level, there are 3 ways that income inequality can arise.  For the sake of illustration (and easy math), let's assume we start with a nation of 100 people, each of whom makes $100/year.  The entire annual economy is thus $10,000, and there is (initially) no income inequality.

How can inequality arise?  I think there are three basic scenarios, and I think it's important to point out that they are not mutually exclusive.  Quite the contrary: I think they all happen, in varying degrees, over time, simultaneously with the others.

Scenario 1: "Malthus Model".  In this scenario, one or two people ("the 1%") enrich themselves at the expense of the rest, but the overall economic pie remains fixed (hence the name "Malthus Model", after the man who predicted starvation due to growth in population that outstripped production).

Bernie Madoff would certainly be an example here, as were the CDOs that sliced and diced mortgages and got rated AAA despite having lots of sub-prime crappy mortgages in it.  I think CEO pay (another OWS complaint) could also arguably be placed here, to the degree that any "excess" pay they get above and beyond the value the create for the company comes at the expense of shareholders and employees.  Whether any CEOs pay is excessive, of course, is a subjective call, but there is good evidence that it has gotten disconnected from CEO value, especially when more than half of company boards target their CEO pay to be above the 50th percentile.  That is, of course, mathematically impossible to achieve, but it results in CEO pay that increases much faster than the underlying fundamentals.

Lotteries, by the way, are also in this model: 100 people spend $1 on a lottery ticket, one person wins $100, so that person gets $99 richer at the expense of the others.

In any case, it seems to me that Malthus-model driven economic disparity is often (though not always, as the lottery example demonstrates) indicative of a problem.

Scenario 2: "Steve Jobs/MicroEconomic Success": suppose that one of the 100 people is Steve Jobs, and he invents Apple Inc.  This creates a huge amount of value, and since the company is Steve's he will keep a significant amount of that value.  Everybody else still makes $100 (or perhaps a they take home little less that year because they buy an iPhone), but Steve makes a lot more money.  So now there is huge inequality between the 1% (Steve) and everybody else.  Two things to note here: (a) the other 99% did not suffer due to Steve (to the degree that they spent money on iPhones, they did so because they felt the iPhone was more valuable to them than the money it cost), and, more importantly, (b) the overall pie grew significantly due to Steve's creation.

I would argue that income disparity from Scenario 2 is not a problem, and is in fact a "good thing."

Scenario 3: "MacroEconomic Changes".  This is arguably a variant on scenario 2, but in this case it isn't that the folks that get rich create disproportionate value and wealth for themselves, but rather that the entire economy grows by some percentage (sometimes negative).  So our economy may grow from $10,000 to $10,400 one year, and then drop to $10,200 the next year.  The inequalities arise here from the fact that the growth (positive or negative) is not spread evenly across the population.

There are many factors why this growth is uneven.  For example, not surprisingly, people with more education and/or more marketable skills tend to weather the downturns better and ride the economic growth more than their less educated or less market-ably skilled fellow citizens.  People who get hurt or sick have trouble even in good times, and may not be able to change jobs due to health insurance concerns.  Our aforementioned lottery winners do well regardless of the economy.  Workers with skills that match open jobs may not be able to take those jobs because it requires them to move and they can't sell their homes because their mortgages are under water (this is proving to be a huge stubborn issue in the current recession given its housing bubble origins).  Macroeconomic trends can change the value assigned to skilled labor, moving jobs to where it can be done more cheaply.  (I can address why I believe fighting this trend rather than adapting to it is generally a bad idea in another post).

There are many moving parts here, many reasons why economic ups and downs affect different populations or economic sectors in different ways.

For that reason, I think that income disparity from Scenario 3, unlike scenarios 1 and 2, does not easily lend itself to a "problem" or "good thing" label.

Furthermore, I think that this scenario is by far the dominant driver of inequality, followed by scenario 2.  I think the Malthus scenario covers too few cases to be a major cause.

And therein lies my issue with the OWS crowd's take on income disparity.  To hear the chanting and slogans and placards, one would think that our income disparity is almost exclusively due to Scenario 1.  If that were the case, then it would be a simple matter of shifting "ill gotten" wealth back to its rightful owners and all would be well again.  But alas, in a Scenario 2 world that sort of explicit wealth transfer truly would be punishing success (hold that thought) and in a Scenario 3 world that probably wouldn't solve anything anyhow.  So I think the OWS crowd is dangerously naive here.

Now before you think I'm totally dissing OWS and everything they believe in, let me put in a defense of the 99%: It is important that we have a strong and vibrant 99%.  If you are a member of the 1%, you need to realize three things.  First, if you think you got to be a 1-percenter in a vacuum, you are delusional.  You did it in a society with good transportation infrastructure, rule of law, low corruption, security, and so forth - all of which are government functions.  Secondly, stability is critical to your success, and places with high concentrations of wealth tend to be less stable than places where there is broad economic participation.  And finally, having a healthy 99% is critical to your continued membership in the 1% club.  Steve Jobs would not have made very much money, after all, if nobody could afford to buy Apple products.

I do not advocate any solution that has a direct aim to reduce wealth concentration.  Robin Hood is decidedly not the answer.  But there are reasonable steps to help ensure that the broad middle has a fighting chance to be economically significant participants in the economy.

Fortunately, America has long done well with this.  For example, we already have a progressive tax system.  Indeed this is (by definition) a higher burden on the wealthy than on the poor, but as long as it isn't punitive, it is a very reasonable way to ensure that healthy 99%.  A 35% top marginal tax bracket simply is not punitive, but then neither was 39.6% (which we had throughout the boom of the 90s) or even a little higher.  (I think when you start hitting 45% or more things start to get punitive).  There are good arguments that the overall size of government needs to shrink - and if so, the rates obviously could come down.  But unless and until that shrinking happens, the tax rates need to reflect actual costs.  "Starving the beast" has yet to actually work to tame government spending.

Another place where America has long shined is in making the Steve Jobs scenario above an attainable dream for anybody willing to put in the sweat and innovation necessary to achieve success.  There's a reason that Apple, Microsoft, Facebook, etc. are American companies.

But the fact is that there remains much more to "solving" income inequality than having a progressive tax system and a good environment for startups, but I think they revolve around addressing the Scenario 3 issues.  Our housing crisis is exacerbating things.  Health costs are devastating for many people.  Our educational system is a mess, and a huge percentage of people studying STEM (Science Technology Engineering and Math subject) are foreigners who twenty years ago would have stayed here with their skills but who are now going back to their newly-stable and newly-prosperous home countries, while more and more American students are studying far less marketable subjects like journalism.

These are not easy problems to solve, and simply transferring wealth does nothing to address them.  If the OWS crowd is serious about addressing inequality, they would do well to focus their energies on real solutions to the big macro-economic challenges that we face, not just getting angry about some perceived "unfairness" that (gasp) some people have more wealth than others do.  That's simply not productive.