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20161210 – Upside of Inequality

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MAIN IDEA:

The main idea here is that growing inequality is not really such a big problem and it is overstated anyway. Moreover inequality is the engine behind the risk taking, innovation, and economic growth would not happen without it. The usual ideas of leftists that incentives do not matter and success is unearned, but rather is matter of luck are just plainly incorrect. Some other myths, which are not true, are:

  • Economy has slowed down because there are little opportunities for investment;
  • Middle class is hurt by progress;
  • Class mobility has declined

The real solutions are change in immigration laws to promote high skill immigration, decrease marginal corporate tax, and apply full accounting for redistribution and government services that would show quite different picture of inequality than the one promoted by leftists.

DETAILS:

INTRODUCTION

Here author refers to his previous book “Unintended Consequences” where he expressed concern that massive blame of the free enterprise system for crisis of 2008 would lead to slower than necessary growth. The point was that high risk / high reward economy is more productive and more efficient than low-risk / low reward one. His point is that Keynesian interference into economy could not create growth because it stifles innovation and discourage savings by inflating money supply. This book is designed to demonstrate power of incentives in moving economy ahead via innovation and risk taking that would not occur in environment of heavy redistribution.

Part I: THE WORLD AS WE FIND IT

Chapter 1. The Causes of Growing Inequality

This chapter confirms growth of inequality with a nice graph:

screen-shot-2016-12-11-at-7-20-07-am

Here are reasons:

  • Globalization: Larger economy rewards stars more even if it decreases cost to consumers: CEO of company with 500000 employees receiving 0.001% of sales as compensations would get millions per year, while CEO of company with 5 employees would starve at this rate of compensation.
  • IT disproportionally benefits most productive people and decrease needs for capital. Here is the graph for this:screen-shot-2016-12-11-at-7-20-16-am
    • Compounding success benefits most productive individuals, by attracting more investment in their intangibles such as knowledge and experience:screen-shot-2016-12-11-at-7-20-31-am
      • Increased risk taking increases inequality because even if increasing majority of new enterprises fails, the few who succeed would succeed with bigger returns, sometime in billions.

      Chapter 2.The Reasons for Slowing Wage Growth

      The same dynamics have negative effects on average wage growth:

      • Globalization brings competition from poor countries where similar talent costs much cheaper.
      • IT and low skill immigration directly restrict wage growth at the bottom and in the middle.
      • Trade deficit strains economic capacity and consequently reduces wages even further.

      Overall trend for commodity labor is to equalize over open global markets and that is what happening: highly paid American labor wages stagnate or even going down via inflation, while developing countries labor wages such as China are growing dramatically.

      Part II: DEBUNKING MYTHS: Mitigating Inequality Is Not the Solution

      Chapter 3.The Myth That Incentives Don’t Matter

      Here author makes a point that growing literature about psychological drivers of risk taking and achieving success are stronger than pecuniary rewards do not really consistent with real live experience that demonstrates that without material rewards innovation and risk taking disappear, even if it does not happen immediately. Movement in both directions has compounding effect so results become obvious only over time. Correspondingly redistribution does not stop innovation right away when most established innovators would continue do what they like, but it would decrease numbers of individuals moving into these activities. Author also points out that high payoff of success does not impede reality that the most benefits are eventually going to consumers.

      Chapter 4. The Myth That Success Is Largely Unearned

      This is the challenge to idea that top earners not really earn their compensation, but rather get it by using their positioning in the business structure: something like CEOs get their compensation defined not by investors but by other CEOs sitting on the board of their company. In exchange they return the favor by voting for high compensation as directors on the board of some other company. To contradict this author presents study that income of CEO did not really grew as proportion of their companies’ income, it is that companies become much bigger. Similarly money managers’ compensation directly related to volume of funds they manage and these volumes increased dramatically. Another point author makes is that CEO job is highly risky, difficult to get, and is usually one time shot after long carrier of acquiring necessary knowledge and experience, so compensation should cover this risk. Overall high-risk high reward pays off for companies and here are some graphs to prove it:

      screen-shot-2016-12-11-at-7-20-41-amscreen-shot-2016-12-11-at-7-20-48-amChapter 5. The Myth That Investment Opportunities Are in Short Supply

      This is about high corporate profits and unwillingness of corporations to invest them back into economy. The inference Keynesians make from this is that government should confiscate unused capital and redistribute either to poor who would increase consumption or just use for more government spending. Author makes important point that in reality investments do not wait for demand, they create demand by providing more and new goods and services that customers did not know they want. The amount of examples is infinite from cars to smart phones. The real constrain is government interference with regulations, confiscations, and limitation of rewards that make such investments not worth trying. Author also looks at government interference into banking business where imposed demands on landing to unqualified borrowers led to crisis. Finally author criticizes an idea of starting economy up via infrastructure investment by referring to Japan huge spending over decades with no productivity growth to show for it.

      Chapter 6. The Myth That Progress Hollows Out the Middle Class

      Here author reviews and rejects idea that progress hollows out middle class. Here is the graph showing relatively small shift in income distribution over decades:screen-shot-2016-12-11-at-7-20-57-am

      Finally author discusses cultural changes dependency on economic changes such as increase in women participation in labor had decreased value of marriage for them or dramatic increase in college education leading to inflation in value of college degrees.

      Chapter 7. Myth That Mobility Has Declined

      The final myth author challenges is decline in mobility. He does it by comparing US mobility with Denmark and finding no significant difference except at the very bottom, where Americans tend to stick relatively more, except for whites who have the same rates as in Denmark:screen-shot-2016-12-11-at-7-21-09-am

      Part III: THE WAY FORWARD

      Chapter 8. Our Moral Obligation to Help Those Less Fortunate

      This is about poverty with usual inference that poor should be helped, but the problem is that help decreases incentives to work, acquire skills, and get out of poverty. The interesting point is that with all this help in terms of access to goods and services American poor actually are rich by international standards. However psychologically it does not help because people live by local standards and to be poor is devastating, even if American poor are fat, have cars, air conditioners, and unlimited access to entertainment and communications.

      Chapter 9. The Limitations of Education

      This is somewhat non-traditional take on education that starts with denial of inferiority of American schools to higher-scoring international schools. It is actually not that difficult to prove. One just has to be a little bit politically incorrect and look at test scores European-Americans separately and see that they are not worse than for children in European schools. The same applies to Asian Americans. After author looks at charter schools, other attempts to improve education, and comes to somewhat trivial conclusion that the best way to improve education is to filter out bad teachers and promote the good ones. He also makes a point of denying direct positive impact of increased levels of education on economic performance of the country.

      Chapter 10. Real Solutions

      Here author provides solutions for the problem of slowing economic growth based on American traditional openness as society and support for risk taking to achieve highly rewarding results:

      • High-skill immigration should substitute low skill illegal and family based immigration
      • Lower marginal corporate tax rates
      • Allocation of all government expenses to households instead of middle-class tax cuts. Here author provide a table to demonstrate redistribution by counting in government services and taxes:screen-shot-2016-12-11-at-7-21-17-am

        MY TAKE ON IT:

        There are a lot of reasonable points here especially about incomplete accounting of transfers and government services, importance of incentives, dependency of investment opportunities on preponderance of societal attitudes, and needs to change nature of immigration. However some of this in my opinion is not justified such as ignoring prevalence of self-dealing by upper classes in control of other people’s money. Whether it is CEO that receives ridiculously huge income in exchange for providing ridiculously huge income to another CEO when voting as a Board Director on compensation, or it is politician in control of public resources using these resources and government power to create foundation for future multimillion income as lobbyist, it is the human nature and expect these people to link their income to their productivity would be unreasonable. I think that inequality is a very important issue not because it hurts economy, but because it creates foundation for all kind of leftist demagogues to undermine or even explode structure of society and therefore it should be minimized as much as possible. However this limitation should be achieved not by decreasing incentives, but rather by making them clearly linked to results of individual actions so negative results should lead to negative returns. When in addition to CEO making millions as 0.001% of company profits we learn about CEO loosing millions as 0.001% of company loses them issue of inequality would go away. I guess the best way is when owners run companies. In the case of huge public corporation when it is not an option I would like to see CEO based compensation limited to some multiplier of average salary of company employees with 100% profits/losses transferred to owners who then may or may not decide provide additional compensation to CEO as they wish. I doubt that this way anybody would complain about inequality, even if total compensation goes in billions.


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