Luck, Investment and the One Percent

by on June 27, 2013 at 7:30 am in Data Source, Economics, Education | Permalink

Jon Chait criticizes Mankiw’s defense of the 1% for focusing on productivity as a reason why the rich earn more:

Mankiw’s essay is a sprawling mess, but it hinges on a few key premises. One is that market wealth reflects a person’s productivity. Higher taxes on the rich, he writes, would take from “the most productive members” of society and give to “society’s less productive citizens,” and he uses “productive” and rich” as synonyms throughout….

But there are lots and lots of ways that a person’s income does not measure his contribution to society. Many of us see them every day. We all know people in our field who earn too much, or too little, because of social connections, or race, or gender, or luck, or willingness to cut ethical corners of one variety or another.

But later in that same article and in a followup he argues that greater productivity is an important explanation for inequality:

Krugman noted (as did I) that more affluent parents spend far more than poor children do on “enrichment expenditures” — “books, computers, high-quality child care, summer camps, private schooling, and other things that promote the capabilities of their children.” (ital added)

Mankiw’s response is that this enrichment spending is all wasted.

…Really — high-quality child care, private schools, camps — it’s all just for fun?…There is, in fact, an enormous amount of research on this very question. And the findings overwhelmingly suggest that nonschool enrichment matters an enormous amount. A huge portion of the achievement gap between poor and nonpoor children is attributable to summer vacation.

The first claim is that the wealthy aren’t more productive than the less wealthy and the latter claim is that they are more productive but that this is unfair. The two claims are in tension (perhaps a synthesis is possible but none is offered). Note also that the two claims have quite different implications. In the former case the rich are lucky and you can tax them without generating large incentive problems. In the latter case the rich have benefited from investment and taxing the benefits is likely to reduce such investment.

Addendum: Mankiw, of course, takes the opposite end of the stick, productive people but unproductive summer camps. Mankiw, however, is not inconsistent as he offers another explanation for productivity, namely earlier developed talents and capabilities possibly even genetic in origin. I don’t want to discuss that issue in this post but here is one relevant earlier post with a bit more here for those interested .

Al June 27, 2013 at 7:54 am

The first claim doesn’t look like “wealthy people aren’t productive”. It claims that wealth does not MEASURE social contribution. Consider a CEO who receives extra funds as an inducement to lower level workers to increase productivity. The CEO is still productive, but at least a portion of the wealth is due to his/her position in a larger arrangement. Chait is focusing upon the wisdom of proxying productivity with wealth.

Frederic Mari June 27, 2013 at 7:56 am

+1. I tried to say something like that but expressed myself more confusedly.

Anon. June 27, 2013 at 8:05 am

I don’t see the connection, though. There will obviously be disconnects between productivity and wealth at the individual level, but that “insight” cannot lead to any judgments on the aggregate productivity-wealth link.

john personna June 27, 2013 at 9:13 am

I think there is a whole body of work on cumulative advantage. Someone will be chairman of every mid-level corp. His salary will be related to the earnings of mid-level corps in general. He may have less to do with “earning” that than he thinks.

Urso June 27, 2013 at 9:31 am

VOR-CEO

Get Bill James on this ASAP.

Hah June 27, 2013 at 9:53 am

+1.

Go KIngs, Go! June 27, 2013 at 12:57 pm

Or Voros McCracken – DIPs. Droneworker Independent Productivity Salary

Anon. June 27, 2013 at 9:49 am

What he thinks is irrelevant though, the question is whether the CEO’s effect is correctly estimated by the board that sets his renumeration, and by extension the shareholders.

Andrew' June 27, 2013 at 10:02 am

Compared to alternatives.

It would not be good enough to simply assert that CEOs are observed to be less than ideal.

If the statists had a magic wand then what have they been waiting for? Control of every branch of government?

john personna June 27, 2013 at 10:10 am

There is also a body of work on how “compensation panels” have ratcheted pay for same-work over time. There are big agency issues boards using friendly panels and those panels choosing “equivalent” positions for comparison with great care.

I really don’t know where Andrew’ is going with “statists.” What we are talking here is game theory.

asdf June 27, 2013 at 10:20 am

It seems obvious based on the data and experience that boards have probably been paying CEOs too much for fairly easy to explain social and game theory reasons.

Andrew' June 27, 2013 at 10:29 am

Everyone knows boards have issues. What are the actual proposals of the people who want to grant the state the power to address the issues? Statists have been in charge for longer than boards have had issues. They don’t actually fix problems.

Also, the top 0.001% is trivial, unless you are arguing they steer the entire economy wrongly- which actually means that selection of the right individuals and EXTREME remuneration would be critical.

Andrew' June 27, 2013 at 10:30 am

Millions of people aren’t poor because 500 CEOs (the rest aren’t paid that much in the big scheme of things) are overpaid. Maybe they are poor because CEOs do a bad job.

Andrew' June 27, 2013 at 10:35 am

CEO pay is 273 times the average worker for just the top 350 firms. I’ll be the first to admit that statists have created a top-heavy economy.

But do you really think that a CEO at a top 350 firm doesn’t have as much effect on the performance of a company as 273 average workers?

Andrew' June 27, 2013 at 10:37 am

As an aside, I love how “CEO” (and 1%) get morphed into the top 350 companies.

I really wish I didn’t have such obvious material with which to ridicule liberals and statists. Oh wait, I only hate Obama because I agree with most people that ACA was dumb and agree with all the left-wingers about his expansion of Bush policies…because I’m a partisan…I guess.

Andrew' June 27, 2013 at 10:51 am

Question #1: Does an increase in fixed cost of a firm increase or decrease the natural size/scale of a firm?

Question #2: Regulation is a fixed cost (a) never (b) almost never (c) sometimes (d) usually (e) always?

Question #3: Regulation is an inverse fixed cost (a) never (b) almost never (c) sometimes (d) usually (e) always?

Question #4: Regulation as an aggregate concept (lobbying, regulators, congressional relationships, etc.) will probably favor (a) unlimited number of corporations or (b) a limited number of corporations

Question #5: Are people who don’t understand these questions (let alone the answers!) more likely to propose solutions that sound good superficially but ultimately make the problem worse or better? If they make the problem worse with their superficial solutions, are they likely to provide more superficial solutions that make it even worse or will they really dig into the details at that point?

For help with these questions:
http://www.holisticpolitics.org/Corporations/Capital.php
http://www.holisticpolitics.org/Corporations/Overhead.php
http://www.holisticpolitics.org/Corporations/Transactions.php

john personna June 27, 2013 at 12:14 pm

Funny how the discussion of pay dynamics lead so quickly to reflex response about the coercive power of the state.

First the invisible hand works, and then it doesn’t, but it is still better than an imagined dystopia.

Heh. June 27, 2013 at 12:21 pm

Question #1: Does an increase in fixed cost of a firm increase or decrease the natural size/scale of a firm? Increase — more barriers to entry usually means less competition. See bulge bracket banks.

Question #2: Regulation is a fixed cost (a) never (b) almost never (c) sometimes (d) usually (e) always? Almost Never. Regulation often scales with a number of factors, such as # of employees or locations of business.

Question #3: Regulation is an inverse fixed cost (a) never (b) almost never (c) sometimes (d) usually (e) always? What’s an “inverse fixed cost”? That wasn’t in any of the readings! (Ok ok… I didn’t do the readings. You got me.)

Question #4: Regulation as an aggregate concept (lobbying, regulators, congressional relationships, etc.) will probably favor (a) unlimited number of corporations or (b) a limited number of corporations? (b). Barriers to entry.

Question #5: Are people who don’t understand these questions (let alone the answers!) more likely to propose solutions that sound good superficially but ultimately make the problem worse or better? If they make the problem worse with their superficial solutions, are they likely to provide more superficial solutions that make it even worse or will they really dig into the details at that point? Is this, like, extra credit? I don’t understand the question. Why would someone who can’t even understand the question have any ability to propose a reasonable solution? Who are these people?!?! Is there another class of people who are able to understand these questions, and answers, and not paint issues in black and white? Is there nuance left in the world? Do I get points for rhetorical questions?

dreamshade June 27, 2013 at 8:08 am

For that matter, I don’t think it’s controversial to say that increased productivity is responsible for the loss of many unskilled jobs in this country, as some of those jobs get replaced by robotics or computers and the like. However, that in no way implies that the top 1% are responsible for that increased productivity—that may be the fault of scientists and other skilled professionals in the top 10%, or even lower down the scale. Is the company CEO more productive than the senior designers and programmers at the company?

To paraphrase Chris Rock, Shaq was almost certainly the most productive member of his basketball team, but the guy who signs his paychecks is the one with the wealth.

Dave T June 27, 2013 at 9:30 am

Chait seems to have a misunderstanding of what productivity means in the capitalist system. It doesn’t matter how hard you work or how productive you are, if you don’t own the capital that allows for you to be productive, you get paid the market wage for that job.

If anything, the fault probably should lie somewhere with the government that has been discouraging savings for so long — if I don’t have the capital to employ myself, well then I’d better be happy with the productivity opportunities I get from others.

Taxing the wealthy more just lowers their capital stock without really raising that of the poor/less wealthy.

Andrew' June 27, 2013 at 9:31 am

Good luck convincing liberals that their polices add to the fixed cost of individual capital.

Frederic Mari June 27, 2013 at 10:00 am

I think that’s a slightly different issue again. If you’re paid only what the market bears and not your MP – certainly the experience of the bottom 80 or 90% – then wages are just supply and demand and nothing to do with MP.

But you cannot say that there is a lack of people willing to do the top jobs so you got to find another explanation than rarity to justify top salaries. Excellence i.e productivity is one way to do that.

At least, that’s how i understood Chait.

Andrew' June 27, 2013 at 10:04 am

Wait, unpack that. I’m ‘willing’ to play NBA hoop.

Frederic Mari June 27, 2013 at 10:23 am

So?

Sure, sportsmen are an interesting limit case. They got obvious, undeniable, talent. OTOH, they’re still not generating all that cash by themselves. If the guy who cut the grass or the guy who point the TV camera refuse to do their jobs, the sportsmen would be unable to claim their cut.

The argument that the cameraman or gardener can be more easily replaced is true but, back again, it means that you’re paid not your productivity (however you define it) but your replacement-cost.

And that still doesn’t explain CEO salaries. It’s not their MP, it’s not their replacement cost.

Go to go but would love to see you guys answer and I promise to reply tomorrow.

Andrew' June 27, 2013 at 12:01 pm

I don’t think replacement cost versus productivity are mutually exclusive. There are more pro athletes than fortune 500 CEOs and I think the obviousness of their talent and the televised nature of their competition makes them a good rather than a poor illustration.

Take the worst NBA player in the league. He is paid a lot more than the guy just a little worse than him who didn’t make the cut. Even though there are lots of people almost his ability level (and maybe better depending on the vagaries of talent assessment and front-office decision-making) he doesn’t get paid zero (although college players kind of do).

(Not That) Bill O'Reilly June 27, 2013 at 12:38 pm

Isn’t replacement cost going to be a function of (expected) productivity? Sticking with the NBA example, the replacement cost for LeBron James isn’t just how much it costs to throw another body into that position; it’s how much it costs to get someone who can perform at the level the Heat expect of LeBron (or to get a group of guys who in the aggregate can produce as much).

The supply/demand factor looks more prominent for a lot of jobs because there is a somewhat clear ceiling on expected productivity (auto workers can only build as many cars as Ford is selling), so getting better doesn’t (or shouldn’t) have a meaningful effect on wages (except insofar as those improvements are broad-based enough to increase the relevant labor supply). At the executive level this changes; that’s the level that effects business growth, which is (at least theoretically) limitless, so that’s where you would expect to see compensation more closely track pure MP.

Frederic Mari June 28, 2013 at 3:43 am

Asides: This reply system for a thread of this size is not… err… efficient! :) No complain, though, it’s better than what I manage with blogger.com. Now, that’s a system where you better not get too many comments! If someone know how to add a forum function to a blog for no hosting costs, I am all ears.

Reply to Andrew’ and (Not That)Bill O’ Reilly: If you assume that replacement cost is purely expected productivity then the whole thing become tautological.

Now, in any case, for team endeavour, I always found productivity to be a somewhat fuzzy concept. Yes, we have a pretty good idea of what we mean but measuring it is hard/impossible.

Now, there is no denying that a good CEO, one that actually alter the company’s dynamics for the better, is worth a heck of a lot. If your company is in dire straits, a turn-around artist can credibly claim all of the money above book value. Personally, my ‘solution’/’recommendation’ to Boards and remuneration committees was to set top executive pay against an industry benchmark. Say, you get paid if the company share price is above the sector index. You can even put some kind of volatility/downside/drawdown limitations. Or, instead of market price, target operating ratios, if you find those more reliable indicator of how the company is doing/will be doing long-term.

Basically, something not too dissimilar to the HF industry, except that, here, there is no AUM gathering game to compensate for poor/average performance.

It still doesn’t address the brute power play between capital and labour when it comes to sharing the spoils but it would mean, at least, that the CEOs who are well paid are well paid because of performance. And 50% of the CEOs would have to make do with a ‘normal’ salary. It would already be an improvement on today’s situation.

mark June 28, 2013 at 11:47 am

Responding to Frederic Mari as to why CEO comp is so high relative to ordinary workers. I’ve made this point on this blog before & some have found it helpful.
CEO salary is usually no more than $1Million because of the Rostenkowski legislation in the late 1980s barring companies from deducting salary in excess of that. CEO comp is comprised mostly of gains upon exercising options. The option is like a commission from the stockholders: take 0.n% of the increase in equity value over the next x years.
It is important to realize that wage and salary are totally different methods of paying someone vs a commission, which is a function of the size of something else – revenue, assets, a transaction etc.

A surprising number of high incomes come from a commission model – an actor may get a % of the gross; a hedge fund manager charges a % of the AUM & a % of the profits; a trader gets a bonus based on his contribution to the desk’s profits; a plaintiffs’ lawyer gets a % of the settlement or jury award; a broker gets a % of the sale proceeds of an asset; and athletes get % royalties on their jerseys – under certain CBAs they get (collectively) a % of the gate as well. Those are just some examples of certain job types that have commission based compensation that has resulted in high income for certain people who perform those jobs.

A CEO getting a % of the stock gains is in the same vein. The % sliced off the stock gains is usually pretty trivial to the shareholders but obviously very large from the persoective of the one individual so an excellent harmonization of their respective interests in the negotiation. And the further advantage for this model is that the CEO’s claims do not come ahead of the shareholders, or in a different form, like wages etc do, but are the same type as the shareholders – yet another thing that makes the negotiation very easy: CEO only gets rich if shareholders get richer.

Now severance payments are a different story and I don’t claim to defend or explain them. This comment being long already, I will not proceed to delve into them.

Hazel Meade June 27, 2013 at 11:25 am

Agree vehemently on the discouraging of savings. I would really like to see a system where people are encouraged to build capital at the lowest level, then become self-employed or small business owners.

It’s almost as if progressive policies are designed to hasten the consolidaton of capital so as to bring about some Marxist idea of how capitalism is supposed to progress to socialism. Discourage everyone to build their own capital and train them to be employees of large corporations instead. Then nationalize all the large corporations and voila, socialism! Look at the way the health-care bill entrenches employer-provided healthcare, for instance.

dead serious June 27, 2013 at 1:01 pm

Don’t let facts get in your way, comrade.

http://www.sba.gov/content/small-business-trends

The 23 million small businesses in America account for 54% of all U.S. sales.
Small businesses provide 55% of all jobs and 66% of all net new jobs since the 1970s.
The 600,000 plus franchised small businesses in the U.S. account for 40% of all retail sales and provide jobs for some 8 million people.
The small business sector in America occupies 30-50% of all commercial space, an estimated 20-34 billion square feet.
Furthermore, the small business sector is growing rapidly. While corporate America has been “downsizing”, the rate of small business “start-ups” has grown, and the rate for small business failures has declined.
The number of small businesses in the United States has increased 49% since 1982.
Since 1990, as big business eliminated 4 million jobs, small businesses added 8 million new jobs.

Turkey Vulture June 27, 2013 at 1:01 pm

I agree incredibly strongly that we need to encourage all people to build capital, and discourage them from thinking that the only route to supporting themselves is a job at some big company.

JWatts June 27, 2013 at 3:51 pm

Don’t let facts get in your way, comrade.

But the quote below your statement doesn’t actually contradict her statement. Did you mean to post something different?

Steve J June 27, 2013 at 4:36 pm

I think dead serious is pointing out if the progressives are trying to create an environment that discourages investment at the lowest level then they are doing a poor job of it. More investment/growth is happening in small business than big business.

JWatts June 27, 2013 at 5:35 pm

I think dead serious is pointing out if the progressives are trying to create an environment that discourages investment at the lowest level then they are doing a poor job of it.

Yes, and the Nazi’s did a poor job of conquering Eurasia, but clearly they gave it a good try. (Apologies to Godwin). So, I kind of see the point, but it certainly isn’t a rebuttal to the argument.

Steve J June 27, 2013 at 7:49 pm

“clearly they gave it a good try”

So it really doesn’t matter what the progressives say or the facts about how their policies impact the market. You just know what they are doing is evil without having to think about it. Certainly that is a simpler way of thinking…

JWatts June 27, 2013 at 11:44 pm

Whoosh.

Frederic Mari June 28, 2013 at 3:50 am

Jumping into yet another piece of this thread, I think you’re kind of talking past each others.

A lot of small scale investment is occurring. Thus, whatever liberals are doing, it’s not THAT bad. Hazel and JWatts’ point is, if I understood correctly, that it could be even better. Right?

And, to be honest, I certainly can think of some improvements. I am not fully cognizant of the US situation but Matt Yglesias is fond of pointing out stupid local regulations that allow existing providers to restrain new entrants in things like restaurants, hair stylists and whatnot. I don’t know how much of a problem it actually is but it’s certainly not favourable to new investments or in the customers’ best interests.

JWatts June 28, 2013 at 11:35 pm

I think you’re kind of talking past each others.

Yes, there is some truth to that.

Hazel and JWatts’ point is, if I understood correctly, that it could be even better. Right? Yes.

mark June 28, 2013 at 11:13 am

I don’t read it that way. I read it as Chait changing the definition of “productive” to one that fits his argument better – “contribution to society”. Whatever that is. In economic terms, there is just a person who sells a product or a service and receives a price paid for that in exchange. That is the person’s productivity. There is no quasi-Platonic concept of a “contribution to society” from that product or service against which one measures the price paid and concludes it is “too high” or “too low” and therefore the person is “more productive” or “less productive” than the price indicates. Chait is basically saying he has a privileged point of view that stands outside of economics from which he can glean the “real” value of products and services and disregard the prices paid fo them. That isn’t economics. It isn’t even science as it’s not falsifiable because he assumes away the relevance of real world data. It’s just claiming he is “keeper of the truth” .

Frederic Mari June 27, 2013 at 7:55 am

Well, this may be a question worth asking Chait directly but, imho, we are again talking about different things.

1- the really toppy top of the pyramid is nearly all rent (finance, lawyers, industrial heirs and top executives). A top ranked diploma is important/very important but most certainly for signalling purposes.

2- the top 1% or even the top 10% versus the rest has a different dynamics: Education is essential too but signalling isn’t the only/main purpose i.e. productivity improvement or developing skills does matter.

Basically, I think that the way to reconcile both statements is to consider the various ‘things’ that make a diploma valuable – the IQ threshold aspect, the actually useful knowledge component, the signalling stuff etc. So being able to invest in a diploma is still a good thing/a necessary thing but even if diploma/educational investment does raise future productivity, it doesn’t mean that the top is not exploiting rent rather than ‘contributing’/being productive.

He does also give a pretty good example about 2 doctors, the difference of income between which is down to market structures (and personal choices, maybe) rather than their ‘productivity’…

mw June 27, 2013 at 8:29 am

The difference between the tippy top reflecting mostly rent (and incidentally also reflecting almost all of the biggest rise in inequality) and the toppish is probably real, and that they’re defending the latter is the usual “out” that inequality-defenders like Mankiw and this blog’s authors give themselves.

But in this case, Mankiw is trying to move the debate “forward” by explicitly arguing that there is no difference. That the tippy top is just a lot of Steve Jobs. Which is unbelievable audacious.

Frederic Mari June 27, 2013 at 8:53 am

Actually, I think this is a classic conservative/right wing ploy. Speak about the top 1% and above as if they were no different from the corner shop owner or the small restaurant entrepreneur…

I’ve mentioned that many times in discussion with my friend James (and on various political forums across the years) and it was always kind-of-acknowledged by my conservative counterparts and then ignored or discarded.

I’ve written myself quite a lot about this because I do think it’s key to our political issues: http://theredbanker.blogspot.com/2012/05/taxes-here-comes-great-reaper-part-2.html

but even more: http://theredbanker.blogspot.com/2013/02/to-conservatives-cant-we-all-be-friends.html and http://theredbanker.blogspot.com/2013/02/conservatives-reply-to-james-comments.html

Morgan Warstler June 27, 2013 at 9:46 am

This is wrong… and it gets to the essence of both productivity and inequality.

The proper way to view class in a Capitalist Democracy is bi-polar game theory with a C-player. Think US vs USSR with China playing the swing.

The A player is the top 1/3 of Americans who will spend part of their life earning the top 20%. Basic pareto, the top 20% know they are delivering 80% of economy, they view themselves as such. They OWN the state, it is of them. it is the source of thinking of someone like Obama as the “other.” They run everything from the churches and schools, they own main street, they vote GOP, they are successful small business owners, etc.

The A player – the HEGEMONY – has both money and votes.

The B player are the elites the tippy top, think the 1%, altho, many in 1% are still reliable A team. – they have NO votes, they have only money.

Crucial to note here: the A team has more money than the B team.

The C player is the botom 66% who will never be part of the productive 20%. They have ONLY votes.

——-

The correct strategy for the C player is obvious, you side back and forth with A and B and play them against each other… just like China.

And the story of the last 30 years as the rich have gotten richer proves it. During this time, the top 1/3 haven’t lost anything – they held their same % of wealth earnings. The bottom 66% have gotten crushed and ALL OF IT went to the tippy top.

The best possible game play strategy for the bottom 2/3 is to offer deals to the top 1/3 where the ENTIRE takedown come from the B player, and MOST of it goes to the A player.

To put this in simple terms, the C player needs to adopt #distributism as their strategy. They want to offer up tax policy that deeply favors SMB owners over Fortune 1000 management and tax luxury corporate business expenses as personal consumption – you pay income taxes on that business class travel, 4 star hotels and dining etc.

This pushes best and brightest to SMB – and distributes wealth more evenly amongst the top 1/3…

So the bottom 2/3 have far more customers for their service based offerings. More yoga instructors…

Frederic Mari June 27, 2013 at 10:03 am

I am not sure you’re saying anything different from what I am saying.

In our political set-up, i think it’s best for the middle class to side with the poor against the rich (i.e. your A and C players band together to teach B a lesson or two) but, in truth, i do think that B would benefit too from a more equal distribution.

I am wary of abusing with links to my own blog but that’s what I meant when I wrote “Elyseum isn’t the best the rich can do”. A strong middle class doesn’t mean just more yoga instructors. It also means more iPad consumers.

Andrew' June 27, 2013 at 10:10 am

“In our political set-up, i think it’s best for the middle class to side with the poor against the rich”

Why?

Turkey Vulture June 27, 2013 at 1:08 pm

It’d also be a good strategy for A, non-B players to side with the Cs, right? Seems like the most recent efforts to increase taxes on the rich are going to most effectively raise taxes on those in the 66-99th income percentiles. That group should favor lower marginal tax rates but higher capital gains/dividend taxes.

Turkey Vulture June 27, 2013 at 1:10 pm

As in, right now, B and C players are both kind of screwing themselves over compared to what they could do.

Hazel Meade June 27, 2013 at 3:47 pm

This is really just a horrible way of looking at economic policy. The worst kind of zero-sum thinking.
Everyone is just an interest group and their job is to use the political system to get the most money for themselves. Yuck.

Maybe C’s immediate interest is in getting more stuff for themselves, but long-term what sort of policies are going to make A, B, AND C all better off? Paying a game of redistributing resources so your faction gets more , or creating a system where people at all levels are encouraged to be more productive and make better financial decisions for themselves.

Do we want people focusing on how they can manipulate the government ot their advantage, or do we want people focusing on how they can produce something that other people are willing to pay for?

Brian Donohue June 27, 2013 at 4:03 pm

@Morgan- good stuff.

Tracy W June 27, 2013 at 10:00 am

Why do you think that such things are all rent? To take top executives, is it not possible that what they do is a very tough job? An executive of a big company is managing the distribution of resources across areas of which they personally can know very little in a very uncertain environment. Furthermore, they are making important judgments about the quality of the people they employ. Finally, they are taking on more legal liability in recent years for the performance of their company, including such things as the accuracy of their accounts, which increases the downside risk and thus would drive up required compensation.

Or a top lawyer – who is someone who is presumably very good at reading and understanding laws, and either at figuring out ways that their clients can avoid legal conflicts, or getting them out of any legal conflicts the clients are already in. Given the adversarial nature of law, this is like sport – a lawyer who is slightly better than the opposition can be a lot better in terms of total outcomes for their client, or their team.

I don’t see why an industrial heir is rent. Whomever earned the money in the first place chose to leave it to their heir. If they had chosen instead to spend it all on luxury goods, or donate it all to their favourite charity, that doesn’t mean that the makers of the luxury goods or the workers at the charity are rent-obtainers.

Finance – I have some sympathy for that viewpoint.

Frederic Mari June 27, 2013 at 10:12 am

:D

Surely, you can make the same points about financiers you made with lawyers and top executives?

IMO, it’s still rent inasmuch as they are benefiting from a silly institutional set-up. Globalisation and technology helps promote winner-takes-all races and, to a degree, there is little we can do about it. At least, we’re getting some benefits out of globalisation and technology.

But, to accentuate these modern givens with our set-up (say, law being a contact sport and remunerating lawyers like sportsmen) is ridiculous.

As to executives, my point is that there are plenty of people willing to do their jobs, their performance does not justify superstar salaries (being a shareholder has been quite unrewarding in the past decade) and therefore it’s hard to say that their pay is related to their work. Again, in our system, they tend to set their own salaries with the help of their friends and without actual control by the shareholders. This is a recipe for rational looting by the top people. I mean, I would do it too. It’s eminently rational from an individual pov.

You’re right about heirs. It’s inherited massive wealth and thus bad but for reasons other than rent.

Cliff June 27, 2013 at 11:17 am

I don’t understand what you are saying about law. How is our “set-up” making lawyers more wealthy? Law is a bloodbath with way excess supply and most people don’t make it. Just because I make a lot of money as a lawyer it makes me somehow a rent-seeker, or it means the laws are set up to make me lots of money or something?

Andrew' June 27, 2013 at 12:07 pm

In the case of lawyers, I’m willing to make an exception.

Turkey Vulture June 27, 2013 at 1:15 pm

Lawyers (and finance people) are more a part of societal transaction costs than rent-seekers per se. If there were fixed rules of the game, competition would tend to lead them to minimize those transaction costs (more or less). But both lawyers and finance people get to play some role in setting the rules of the games the operate within, such that they can actually increase the transaction costs they feed on. Perhaps this latter portion of their remuneration is best identified as rent.

Finch June 27, 2013 at 2:15 pm

Our system is certainly not perfect, but _any_ system which attempts to be reasonable and fair is going to spend a lot of money sorting out complex disputes with a lot at stake. Conflict between big firms is going to be expensive to sort out. Murder trials are going to be expensive. It’s worth applying the efforts of smart people to these problems.

Floccina June 27, 2013 at 1:09 pm

The justification for high CEO compensation is not that it is a tough job, it is that small mistakes can be very costly. Paying a huge amount for an experienced guy might make sense.

The other reason for high CEO pay is that total top executive compensation of the top 500 companies, and that is what we are talking about, is too small a part of the top 500 companies’ profits to even think about. Carl Icahn does think about it and people who object to high CEO pay can invest with Carl Icahn thorough IEP. Few others bother because top execute compensation is usually less that a typical year’s net income growth and if the new executive makes a small mistake you might be worse off.

(Not That) Bill O'Reilly June 27, 2013 at 10:04 am

“[T]he really toppy top of the pyramid is nearly all rent (finance, lawyers, industrial heirs and top executives).”

I have no empirical data to back this up, but my impression is that the very tip-top (0.01% or whomever) are largely the successful self-made billionaires most people tend to respect (Steve Jobs, Bill Gates, the Chobani Yogurt guy), while the ostensible rent collecters (particularly lawyers and doctors) are a tier or two down from there (Finance guys, who scale across both tiers, also seem to vary significantly in how much they earn from rent and how much they earn from genuine financial innovation, so I consider them a wash for the purposes of this argument). This leads to a confused and unproductive discussion when it comes to raising taxes; “soaking the rich” isn’t nearly as compelling if there’s a level of disconnect between the people to whom the justification applies (“they didn’t really earn it”) and the people who will bear the majority of the new tax burden.

If the problem is rent collection, the solution isn’t for the government to collect rents on those rents; it’s for the government to eliminate the regulations that allow rents to accrue in the first place.

Frederic Mari June 27, 2013 at 10:18 am

It’s getting a bit late my side of the world and I got to go but I wanted to reply quickly because you’re raising a great point.

Basically, I too would favour what has been called pre-distribution (i.e. acting at the level of the wage/profit split) rather than redistribution (i.e. taxing the rich and distributing the tax income). I am also quite interested in exploring the idea of an exploding VAT i.e. one that rises with the luxuriousness of the purchase. But the problem there is that you cannot simply take the price of the item. Buying a top-of-the-line car is certainly a luxury but buying a middle-of-the-range one isn’t. Yet a ‘normal’ car would still cost you far more than any other consumer good.

So basically variable VAT cannot be just about the amount spent. And if you start having variable VAT inside product categories, it’s going to be a logistical nightmare, imho.

There’s data, btw, about the composition of the top 1% and top 0.1%. For it to be all high tech billionaires and entrepreneurs, you got to go even higher, iirc.

Turkey Vulture June 27, 2013 at 1:20 pm

Differential VATs would also lead to a ton of resources wasted on lobbying for a given product to be classified at a lower luxury level. Really that is an issue with any solution that requires potentially-subjective classification, which most things that aren’t purely numbers based will tend to be. Maybe the gains elsewhere would exceed the losses from lobbying, but it’s another thing to consider.

Floccina June 27, 2013 at 2:25 pm

I think what you are trying to get to is a progressive consumption tax. I think that would be better done by allowing people to put money into a tax exempt account without a limit, and taxing them on any money that is earned but not put in the account plus withdrawals from the account. The account would allow many types of investments include investment in a non public company.

asdf June 27, 2013 at 10:38 am

Is Bill Gates a self made billionaire?

Gates came from a wealthy family and had a lot of support and great educational opportunities and connections. He also had a guaranteed safety net if his entrepreneurial ventures failed. Most people don’t have that.

Moreover, he’s a billionaire because his business partners dropped the ball and handed him windows. Had they made an even slight change in the legal terms by which the contracted Gates, something that was certainly possible, Gates would have done the same work but never became a billionaire.

Somebody has to benefit from network effects. Somebody has to be the lucky one who happened to have a controlling share in the entity that won the lottery. We can improve our odds, but lets not pretend it isn’t a lottery. Or that the winner is the winner because they were the best or that they alone created all that value (hint, the people working under them and for other companies in their network created a lot of the value, but because of the bargaining position of the people at the top they capture a lot of that value themselves).

Gates gets this of course. Which is why he doesn’t mind redistribution and gives away a lot of his money.

Keith June 27, 2013 at 11:04 am

Yeesh. That is a biased description.

Gates’ family was upper middle class, certainly not wealthy.
His business partners didn’t see the value in their draft version of WIndows, again that is a credit to Gates.
He was lucky in the sense that he was an early adopter of an earth-shaking technology, but the rest was him and the people he hired.

mw June 27, 2013 at 11:07 am

I don’t know how many times we can say this, but Bill Gates is irrelevant. Browse the Forbes 400. Give me the Steve Cohen version of this story.

Dan Weber June 27, 2013 at 11:20 am

Gates was undoubtedly lucky: there were probably only a thousand people in the world who had access to the prerequisites to grab the OS monopoly.

Gates was undoubtedly smart and worked extremely hard: where are those other thousand people now? It’s one thing to have the opportunity, it’s another to actually try to achieve it.

asdf June 27, 2013 at 2:40 pm

He was 1%, or at least close to it. Father was a successful lawyer from a good line and afforded Gates educational and social advantages (he met his co-founder, Paul Allen, while attending private school together growing up). Also, it was Allen who spearheaded the idea to purchase the system that eventually became DOS. Many of the people that would be critical to Gates early success were people he met while young due to the path his parents were able to put him on.

Side note: Gates father literally wrote the book “Wealth and Our Commonwealth: Why America Should Tax Accumulated Fortunes”

“His business partners didn’t see the value in their draft version of WIndows”

Sure, but they still wanted it. And they still paid for it. They could have demanded a very different agreement from Gates and he still would have accepted it. The point is that very tiny changes in legal arrangements could have made massive differences in the wealth Gates has, even if his productivity remains the same.

asdf June 27, 2013 at 2:43 pm

Dan,

Perhaps they also tried but were unlucky. It seems to me what we want to maximize is trying, not rewards for the lucky winner. Fear of the results of failure, more then the marginal tax rates on success, seem to be the bigger determinate of the chances people are willing to take. If you take some from the winner of the lottery to cushion the fall of the losers more people will be willing to play the lottery.

dave g June 27, 2013 at 6:59 pm

You act as though there’s no such thing as risk. To drop out of college, to start a company, to invest in a discarded technology, those are risks that are rightly rewarded when they pay off. All the 1% folks I know achieved their wealth by a combination of prudence, deferred gratification and risk taking. If they had a safety net to fall back on, then I guess you can say they weren’t self-made. BUT, I know hundreds of people who could, but will never, rise above uppper middle class, because of their risk-aversion.

mw June 27, 2013 at 11:01 am

Please enlighten us on how “eliminating regulations” will do anything to address the fact that children of the poor are no dumber than children of the rich but nevertheless much less rich than children of the rich?

Cliff June 27, 2013 at 11:19 am

Well as a matter of fact, the children of the poor are dumber than the children of the rich, aren’t they?

I imagine eliminating regulations would help by eliminating barriers to entry into well-compensated fields, for one thing.

mw June 27, 2013 at 11:22 am

“As a matter of fact” no they’re not on average if you control for race, not until they’ve started reaping the child-rearing benefits of being rich.
http://economix.blogs.nytimes.com/2013/06/26/bridging-the-income-barrier-at-top-colleges/

Andrew' June 27, 2013 at 12:14 pm

Reinforcing the college system is probably the wrong way to go if the college system is reinforcing inequal outcomes.

By the way, where does your link show the poor and smart are the same ability? Also, did the researcher of your link mail her stuff to the higher family income students?

Cliff June 27, 2013 at 12:55 pm

Well, excuse me if I am skeptical of a single graph with no data or paper, when previous literature has found the opposite. What is “young children”? One-year-olds? Aren’t these the authors of that notorious one-year-old race/IQ study? Isn’t it true that parenting and other environmental factors matter less and less over time while the graph shows the IQ difference growing over time? How do you control for home environment unless it is an adoption study?

Andrew' June 27, 2013 at 1:00 pm

I’m always cool with any data. I accept almost all of it.

What I take exception with is the subsequent logic.

They fine a HUGE difference with ONE MONTH of age! That means the slope of increasing cognitive ability is so steep that trying to measure anything else is nearly a fool’s errand.

Keith June 27, 2013 at 11:52 am

So if poor children are just as smart as rich children, and life outcomes heavily depend on intelligence, both groups should be fine then. Right? No need to meddle. We should accept both groups the way they are. Diversity!

Huh? June 27, 2013 at 1:53 pm

I can’t tell if you’re being straight-up sarcastic or so sarcastic you became anti-sarcastic…

(Not That) Bill O'Reilly June 27, 2013 at 12:47 pm

If there are high barriers to entry into lucrative professions (i.e. “regulations”), that would seem like a pretty good explanation for your observation that equally intelligent children experience wildly divergent life outcomes purely on the basis of family wealth.

It would also have the doubly perverse effect of raising the costs of certain professional services, thus eating up more of the income that borderline families would otherwise devote to helping their kids succeed.

x June 27, 2013 at 5:00 pm

The solution to that is to make it illegal for poor people to have more than one child or even any children at all.

That will cause the poor to simply die off.

celestus June 27, 2013 at 11:06 am

“the really toppy top of the pyramid is nearly all rent”

Depends on your definition of rent, no? If I buy Apple at $50, and sell it at $400, that isn’t “rent.” If someone says “make money on stocks and I’ll give you 20% of the profits” and I buy Apple with their money at $50, sell it at $400, and make $70, I’m hard pressed to explain why that’s rent- I guess the network effects? Some guy invests his money with my hedge fund because we went to the same college? I still bought low and sold high, and that created value for my customer. If anything, among billionaires it’s Jobs, Gates, etc. who are almost entirely rent-earners, not the finance guys- that’s the whole point of IP law.

Not to mention that the lower middle of the pyramid is very clearly “nearly all rent.” How much does KFC pay its American employees vs. its Chinese ones, to do the exact same job? 5x as much? 10x?

Cliff June 27, 2013 at 11:14 am

I’m looking at your four examples of renters and I’m not seeing it. Why are any of those jobs rent-seeking (or rent-receiving)? Maybe you have some argument for top CEOs but that’s like the top .00001% or something, right?

Evan June 27, 2013 at 7:57 am

If Mankiw is right, that spending on enrichment activities doesn’t matter, then the wealthy are spending their money inefficiently and the market should correct for that in some way. And if not through seeing their money wasted as their children fail to succeed in spite of dollars spent, then through taxes that correct for the inefficiency.

Anyway, there are much better critiques of Mankiw’s argument than Chait’s out there (http://www.economist.com/blogs/democracyinamerica/2013/06/inequality?spc=scode&spv=xm&ah=9d7f7ab945510a56fa6d37c30b6f1709). My own take, to try to stay related to this point, is that it’s not so much that the rich aren’t necessarily more productive, but that it’s hard to believe they are more productive to the extent to which they are being compensated. It also baffles the mind that anyone could look at the current distribution of those earning in that 1% category and claim that those are the only people with a MPL worthy of that compensation. If productivity is some innate, natural proclivity, why is it not more uniformly distributed across sub-populations? Or even just relatively more balanced between men and women?

Anon. June 27, 2013 at 8:10 am

>Or even just relatively more balanced between men and women?

Because humans are a polygynous species, and as with every other polygynous species out there, the males exhibit far greater variability of fitness than the females.

The most obvious manifestation of this is in the variance of IQ scores which is higher for men than it is for women. The further out you go on the right tail of the distribution, the greater the ratio of men to women.

mw June 27, 2013 at 8:24 am

Particularly the white males working as corporate executives that make up the right tail of the income distribution, which is obviously a reflection of the IQ distribution. But you don’t wanna catch em too young, because then you can’t tell the difference.
http://economix.blogs.nytimes.com/2013/06/26/bridging-the-income-barrier-at-top-colleges/

Cliff June 27, 2013 at 12:13 pm

You mean at one year old? Yes it is hard to tell a difference in IQ at 1 year old. By 3 or 4 it gets pretty obvious.

mw June 27, 2013 at 1:08 pm
Cliff June 27, 2013 at 1:31 pm

????

The link is supposed to show…?

Andrew' June 27, 2013 at 12:18 pm

Your link shows the biggest effect to measurement in ability is a month difference in age…which is just one obvious way the school system sucks.

Evan June 27, 2013 at 8:26 am

This is absolutely a cop out. Evolutionary biology is hogwash. IQ scores don’t measure ability, they measure how well you take an IQ test. Fitness is also a problematic term. Women exhibit higher tolerance for pain than men, and I mean, childbirth.

Also, since when is running the 100m dash or maxing your benchpress a pre-requirement for getting a top 1% desk job?

Finally, even if I concede this inane point about “physical fitness,” then the distribution among different races of men should be more even. Or even skewed toward the most “fit” men. It’s not.

Anon. June 27, 2013 at 8:31 am

>IQ scores don’t measure ability, they measure how well you take an IQ test.

Are you saying the correlation between IQ scores and academic achievement, income, etc. is spurious?

Also, fitness does not refer to “physical fitness” but the ability of an organism to 1. survive and 2. reproduce successfully.

Frederic Mari June 27, 2013 at 9:02 am

With regards to IQ and success: How much of that is due to a degree or even more specific degrees acting as gate-keepers? Because my experience is that high IQ certainly does not explain business success.

Fitness is ridiculous as a criteria in the sense that it’s pretty easy to have kids and for them to ‘survive’. That part truly is evo psy hogwash (and, in general, I am quite okay with evo psy as long as it’s not simply a mask for ‘the 1950s set-up is the ‘natural’ one.”

Are you seriously pretending that there is a genetic reason for boards to be populated by white males? Please.

Furthermore, as I said elsewhere ( http://theredbanker.blogspot.com/2012/11/the-true-lessons-of-recession-really.html ), if our boards are populated by the best and brightest, how come being a shareholder for the past 10 years sucks? Where is all this brilliance going? Not in stock price growth, not in dividend growth… Where?

Andrew' June 27, 2013 at 10:12 am

IQ tests aren’t perfect so dice rolls are?

These people who would roll their granny to make a buck…they practice racial solidarity?

celestus June 27, 2013 at 11:40 am

“being a shareholder for the past 10 years sucks”

The S&P 500 total return over the last 10 years is about 100%. http://ycharts.com/indices/%5ESPXTR

Dan Weber June 27, 2013 at 11:44 am

Dude, you mean we have to include dividends when calculating returns?

Math is hard, let’s go shopping

Cliff June 27, 2013 at 12:16 pm

“Your experience” is worth diddly-squat. We’re not talking about evolutionary fitness on a 50-year scale, that should be obvious. We are talking about the way males and females have evolved over millions of years and the result of that evolution is absolutely indisputable. Please don’t argue about this because it just exposes your ignorance. This is not subjective stuff, it is objective fact.

Floccina June 27, 2013 at 2:39 pm

If you who say the riches enrichment of their children’s environment makes it so difficult for the poor to move up how the children of poor immigrant Jews do so well in academics and business and how did the children of poor blacks come to so dominate popular sports?

Brian Donohue June 27, 2013 at 4:14 pm

“if our boards are populated by the best and brightest, how come being a shareholder for the past 10 years sucks? Where is all this brilliance going? Not in stock price growth, not in dividend growth… Where?”

If you invested $100 in a S&P 500 mutual fund on June 27, 2003, you would have $202 today- a 7.3% annual return.

Yancey Ward June 27, 2013 at 10:35 am

Yep, every guy I have ever seen give birth screamed for the pain medication.

Careless June 29, 2013 at 2:33 am

Aside from everything else he wrote being wrong, he’s wrong about the pain thing. Men have higher pain tolerance

Popeye June 27, 2013 at 10:01 am

Yeah, and this is also why the C-suite and country clubs in America are dominated by Asian-Americans.

Oh wait, let me guess, being a CEO is about more than having a high IQ and being able to solve differential equations. It’s about communication and presentation. CEOs are basically talkers, not scientists.

Which is why there are so many women business leaders, because men are intrinsically horrible at communication while women excel at it.

It all makes sense, really, like some law of nature.

Tom West June 27, 2013 at 11:49 am

+1

Cliff June 27, 2013 at 12:17 pm

You want to compare the income of Asian-Americans versus other groups, then? Limiting your analysis to CEOs is stupid.

Popeye June 27, 2013 at 12:39 pm

I’m interested in the “right tail” of the distribution, as per the comment I was replying to. We don’t have to limit to CEOs, we can restrict ourselves to senior management at large corporations, board members, powerful government officials, partners at law firms, and so on. Basically places where Asian-Americans are invisible despite their higher IQs and higher average incomes.

Cliff June 27, 2013 at 12:58 pm

Then why don’t you actually find out what the distribution is in the top 1% instead of making these roundabout accusations? Plenty of Asian doctors in the top 1% I am sure.

Popeye June 27, 2013 at 1:03 pm

Asians make up 5% of the country and 7% of the top 1%.

Cliff June 27, 2013 at 1:32 pm

Does that not undercut your argument? I mean it’s far from conclusive but it’s certainly not inconsistent with the idea of higher IQ leading to higher incomes and higher representation on the right tail (1%).

jc June 27, 2013 at 2:01 pm

Cliff, he was being sarcastic.

Popeye June 27, 2013 at 2:07 pm

No. Asian Americans make up 15-20 percent of the student body at Harvard despite probably facing higher admission standards than other groups. They have much higher average incomes and IQs than other groups. Given all this, the fact that only 7 percent of the 1 percenters are Asians is strong evidence that the right tail of the income distribution is not simply the right tail of the IQ distribution with some noise thrown in.

Cliff June 27, 2013 at 2:08 pm

I recognize that his first post was sarcastic, but I am not certain what his actual point was. It seemed to include that Asians are under-represented in the top 1% because they lack other talents not encompassed by IQ.

Popeye June 27, 2013 at 2:45 pm

Look, I was responding to a bullshit comment that threw around terms like “fitness” “variability” “right tail” “polygynous species”. This is pseudo-scientific nonsense that simply isn’t relevant to debates about the 1% and the fairness of society. The whole rationale for bringing IQ into the income debate is that it suggests some deeper order of things, that societal outcomes are basically revelations of underlying genetic quality which can also be measured by IQ. People trot out Asian-American IQs all the time as a way of distinguishing scientific interest in racial differences from white supremacy, but when Asians fail to dominate the right tail of the income distribution we suddenly have other unspecified “talents” that really matter for life success.

On the other hand, I’ve never been able to convince someone engaged in circular reasoning that they were engaged in circular reasoning, so carry on.

Cliff June 27, 2013 at 3:29 pm

Thanks, I did not understand what you were getting at. So you think Asians are much smarter and more productive and should be even more over-represented in the elite, but their “under-representation” in the 1% is due to racism? I mean I think income is in large part determined by ability, including IQ, but with a huge amount of noise. But noise doesn’t matter in the aggregate, so there has to be some explanation if indeed they are under-represented. The only two explanations I can think of are racism or traits not encompassed by IQ. But then I am not convinced they are under-represented, really.

Popeye June 27, 2013 at 4:28 pm

I bring up Asian Americans not because I’m advocating for (or against) them, I bring them up to cast doubt on a certain pseudo-scientific perspective that seeks to assure us that life outcomes follow simple mathematical laws. Your hypothesis that income = ability + random noise is essentially irrefutable, because it simply identifies systematic differences in income with systematic differences in ability. We can only contradict it if we have some way of measuring ability that is independent of measuring income. This is where IQ scores typically come in, but when Asian-Americans turn out not to make up 15-20% of the top 1%, we apparently have to conclude that other “abilities” come into play. This is a fancy way of saying we have no idea.

dave g June 27, 2013 at 7:12 pm

re:asians in the top 1%

If Asians aren’t over-represented in the 1%, don’t blame “the system.” As I mentioned earlier, for many people, making it into the 1% by income ($350k/yr) may require behavior or risks unattractive to different cultures. Suppose more Asians (or caucasians or whoever) decide that $300k and being home by 5pm is good enough. Suppose a stay-at-home mom and not moving every 4 years for a new position are fine, as long as you make it into the 2% with your measly $300k. Does that make them unsuccessful? Does that demonstrate systemic bias?

Tracy W June 27, 2013 at 10:09 am

For the wealthy spending money inefficiently, well, one of the ways that the market is correcting for that is by publicizing research that this spending is inefficient. Though the difficulty is not the people who see their money wasted as their children fail to succeed in spite of dollars spent, but the people who see their children succeed and fail to see that their children would have succeeded regardless of the dollars spent.
(And why should taxes be applicable here? Are you saying that the childless rich, or rich who raise their kids cheaply, should be taxed less? Doesn’t this rather fall into the category of micro-management?).
As for productivity being uniformly distributed across sub-populations, what human characteristic is uniformly distributed across sub-populations?

Andrew' June 27, 2013 at 10:13 am

Yeah, people are sure giving the rich a lot of credit. As I keep saying over and over, I’d gladly spend a lot of money failing to improve my kid’s IQ by one point because noone can tell me definitively it won’t work. And what else am I going to do with the money? Ethnic cuisine adventures. Harumph!

Dan Weber June 27, 2013 at 11:08 am

If Mankiw is right, that spending on enrichment activities doesn’t matter, then the wealthy are spending their money inefficiently and the market should correct for that

How?

If there is a 1% chance that spending $20,000 per year will improve their kid’s outcome by 1%, they’ll spend that. Why not? They have to spend their money on something, they might as well spend it on their kids.

(And the most significant benefit they see from $10,000 summer camps is that their kids only interact with the kids of the other super-rich. By definition you cannot ever contain prices on this.)

I’d love to see the “abundant research” that, once you do the work to be born into a top-1% household, further enrichment has significant effects on outcomes.

Andrew' June 27, 2013 at 7:58 am

By “race” I assume he refers to Al Sharpton.

Ashok Rao June 27, 2013 at 7:59 am

Nothing inherently contradictory about the point that a doctor is on the whole more productive than an auto-mechanic. But because of the AMA, productivity does not explain all of his income advantage. I don’t see anything difficult to accept about that claim, liberal or conservative.

Regarding the tax scheme: It’s interesting that you point this out, because the new liberal (and convincing) paper going around suggests that decreasing marginal tax rates at the top encourages such employees to negotiate for higher wages (and presumably spend some time doing it, otherwise why wouldn’t they anyway). This would seem to contradict the idea that at the top people do not respond to higher wages. That’s a more important “synthesis”, if you ask me.

Also note that this clearly forwards the case for intense luxury taxes. We’d probably clear a bunch of positional externalities as well.

Andrew' June 27, 2013 at 9:05 am

It is also the voters. They force a division-of-labor fail by requiring excessive knowledge and experience in the people we call doctors. Thus, it is nearly impossible to provide individuals capable enough, the number of slots is artificially (through AMA and voter mandate) as well as naturally limited and resolved through tournament and outsized reward and thus they are incredibly expensive.

Jay June 27, 2013 at 8:00 am

“A huge portion of the achievement gap between poor and nonpoor children is attributable to summer vacation.”

Correlation proves causation?

8 June 27, 2013 at 8:19 am

I think this is an example of via negativa. Poor children spend more time in public schools. Wealthy children, and that would include homeschool children because their parental involvement is very high, spend a lot of time, probably nearly all of it, outside of public schools.

anon June 27, 2013 at 8:36 am

Yes, I love how affirmative action in college provides cover for lousy K-12 education in public schools. Lovers of the state win at both: public teacher unions and academics and administrators prosper, all subsidized by state subsidies (tax dollars) and all while doing it for the children (and all while socializing the children to defer to their betters). It’s brilliant!

Not to mention that many parents use summer camps not to “enrich” their children but to get the kids out of their hair for a while.

Andrew' June 27, 2013 at 9:16 am

I want to see this huge pile of studies. I am confused by this. What do the rich do instead of Summer vacation? Do the rich have schools that go year round? Is it possible that time away from school, warehousing, and poor kids and time spent with high human capital parents in Summer is superior?

(Not That) Bill O'Reilly June 27, 2013 at 10:10 am

I have no ideas what studies Chait refers to, but I got the impression he believes that children from wealthier backgrounds get to go to stuff like space camp that help them to avoid forgetting material over the long break I’ve read estimates of a month to get kids back up to speed from everything they forget; if wealthier students are a month of education ahead every year, that adds up over time (and can be compounded by the better-prepared-but-not-necessarily-smarter kids being chosen for more advanced classes).

Andrew' June 27, 2013 at 10:17 am

Your example of space camp would surely make me doubt Chait’s claim. Noone studies space camp in school (and almost noone goes in the Summer by the way).

I also doubt that education compounds the way the claim would be dependent on as you describe. If it did, the rich would demand constant schooling and graduation of high school for all rich kids at age 10. But that’s obviously not possible, is it? A 10 year old, on average, might be able to learn what an average 12 year old can (we aren’t talking about genius savants here), but on average they can’t compound like interest.

I simply think that there is a huge assumption about how effective education is and then wild assertions are stacked onto the erroneous assumptions.

Marie June 27, 2013 at 10:04 am

It seems likely that if a rich couple sends their 2.1 kids to summer camp so their income stream continues uninterrupted, and this sort of thing continues for 18 years, that means a huge increase in income — easily millions for two attorneys, etc. A kid who hits adulthood with multimillionaire parents hardly needs to be educationally rich. Of course, those programs give cover for college and career placement the kids really gain because of their family wealth — you can justify it because they had all that summer internship stuff.

8 June 27, 2013 at 11:22 am

Do public schools still give homework over the summer? One school I went to made us read books and write book reports that had to be turned in when school started. This was even for kids in second grade. I didn’t have to do that at a public school until I reached AP level in high school. Meanwhile, homeschool kids read books all year round, class never really ends.

prior_approval June 27, 2013 at 8:07 am

The rich getting richer is just one of those things that isn’t hard to prove, and yet the explanation remains so tantalizing out of grasp, doesn’t it?

‘…he argues that greater productivity is an important explanation for inequality….’

No, the argument is that wealth leads to advantages, encompassing ‘other things that promote the capabilities of their children’ – most particularly, the undeniable capability to possess wealth by inheriting it. Something that only the wealthy get to experience – because enrichment has an entirely different meaning in this particular case.

Frederic Mari June 27, 2013 at 9:03 am

I think you just offered a pretty convincing explanation of why the rich get richer. Not so tantalizing out of grasp after all? :)

Andrew' June 27, 2013 at 9:18 am

Or, advantages have almost nothing to do with it, or they are already compensated for greatly by scholarships, free public schooling, etc. And maybe smart parents have smart kids and smarts matters. See, if you don’t just assume your priors you could come up with some ready questions.

Dave T June 27, 2013 at 9:35 am

Ownership of capital allows one to be more successful in a capitalist system? Who would have thought?

Maybe we should be encouraging everyone to save and attain more capital for themselves.

Andrew' June 27, 2013 at 10:59 am

It does that in EVERY system. The capitalist system simply says that it’s okay and maybe even a good thing.

Cliff June 27, 2013 at 12:24 pm

Is that kind of like how winning the lottery works out so great for poor people? Just give ‘em a bunch of money and they’ll get richer?

Really, a fact. June 27, 2013 at 2:14 pm

Adopted kids are uniformly poor, because they genetically had no choice but to fritter away their parents’ money.

That’s a fact.

Cliff June 27, 2013 at 2:26 pm

I’m very confused by your comment. I think you are trying to make some point about genetics not being related to how good you are at finances? You don’t think smarter people handle money better and employ their capital more productively?

Careless June 29, 2013 at 2:44 am

“summer camp key to inheriting more wealth” do go on, I’m taking notes. This is good stuff.

mw June 27, 2013 at 8:16 am

“Mankiw, however, is not inconsistent”

Really? Cause it sounds like if all that money spent on childhood enrichment is “wasted” then somewhere there’s a whole lot of tutors and college advisers who are making more than they deserve.

Which is a freaking hilarious self-contradiction.

Frederic Mari June 27, 2013 at 9:05 am

And, if all that para-education is wasted, then why should we believe that education truly leads to greater productivity and thus justifies the elite being the elite?

Andrew' June 27, 2013 at 9:22 am

You might need to refine your understanding of consistency and self-contradiction.

Tutors are not the big piece of the puzzle. Almost everyone knows that a lot of education, medicine, etc. are wasted. Almost noone talks about that observation in terms of the problem being that service providers “get paid more than they deserve.” Nurses and tutors are just doing what they are instructed to do. They are not part of the 1% because consumers are sometimes irrational.

Andrew' June 27, 2013 at 9:33 am

For example, does trying to address the human desire to get to the top by putting a floor under everyone simply increase the total spending on getting ahead?

mw June 27, 2013 at 10:59 am

“Almost noone talks about that observation in terms of the problem being that service providers “get paid more than they deserve.”””

I think you meant almost EVERYONE talks about that observation in terms of service providers getting paid more than they deserve. Some real mental acrobatics here.

Andrew' June 27, 2013 at 11:09 am

If I argue with my wife that buying roses is a waste of money because they are dead in moments and she says “but I like getting flowers”, neither of us are talking about the florist getting more money than they deserve. You are doing the mental acrobatics because you have to dig at Mankiw.

Dan Weber June 27, 2013 at 11:46 am

Ding ding ding. It’s consumption spending, not investment spending; even if they justify it to themselves by calling it investment.

mw June 27, 2013 at 11:03 am

The argument is patently absurd. Where is the “wasted” money going? To people. Who Mankiw tells us are paid what they deserve. So they produce nothing and are paid lots of money for it. So the market sucks. Except that it doesn’t.

But wait, I bet there’s some big government bogeyman leading to college tutor rent-collection, right?

Andrew' June 27, 2013 at 11:10 am

If you pay someone to dig a hole and then fill the hole back on, you wouldn’t pay them zero.

mw June 27, 2013 at 11:16 am

WOW. Their *product* is zero. That is what and only what this argument is about.

Andrew' June 27, 2013 at 12:24 pm

No it’s not. It might be if I were controlling the debate, but the argument is almost entirely about people with more money versus people with less money.

It almost certainly isn’t the case that the proverbial CEO has a zero product. The question is what his personal contribution is, whether he should collect the positional contribution, etc.

Cliff June 27, 2013 at 12:26 pm

Is it zero if you wanted them to dig a hole and they did it? Maybe you just wanted to watch?

Andrew' June 27, 2013 at 12:58 pm

This is getting uncomfortably homo-erotic considering I’m paying a guy to dig a ditch right now.

mw June 27, 2013 at 1:23 pm

Is the CEO’s marginal product $50mil if you’re paying him not for his contribution to the company but for giving you a seat on the board? Great insight.

Benny Lava June 27, 2013 at 8:38 am

So the assertion is that a hedge fund manager is more productive than a chemical engineer? Something’s rotten in the state of Denmark.

Andrew' June 27, 2013 at 9:06 am

Why?

I resemble that remark…

Anon. June 27, 2013 at 11:12 am

Just because the benefits of increased price efficiency are not directly observable doesn’t mean they’re not there.

Andrew' June 27, 2013 at 12:29 pm

As we used to say “we get paid whether we are writing or erasing.” On the other hand, a capital allocator that directs a chemical engineer toward a successful pharmaceutical and away from an unsuccessful one would have an enormous impact on productivity. We are talking hundreds or thousands of chemical engineer equivalents…assuming they actually could have such an impact.

Benny Lava June 27, 2013 at 1:52 pm

Sure there are benefits, but why would we assume that compensation is wholly due to productivity?

JLK June 27, 2013 at 8:49 am

Some of the apparent tension is resolved if you don’t think of the wealthy as a single person. Among the 1%, it is possible that many have special talent (or not), many had access to complementary social and financial capital (or not), many are productive by dint of hard work (or not), or that some were in the right place at the right time, as in Gladwell’s example of New York antitrust lawyers in the 1970s (or not). Which part of the Venn diagram you draw your examples from provides existence proofs for a lot of different views of the 1%, without being inconsistent.

Andrew' June 27, 2013 at 9:54 am

Some people want to say that the 1% (and they are really talking about the 0.1% or even the 0.01%) can be judged based solely on their W-2 rather than actually judging based on details. Those people mainly just want to tilt elections in their favor in the short-term and create divisions between groups and classes in the longer-term.

asdf June 27, 2013 at 10:44 am

Sure, but what are you going to do? Appoint a judge to evaluate what the individual taxes every single person should pay based on their “worthiness”.

For obvious political and logistical reasons people must be divided into groups, we have to make some statements about those groups “in general”, and then enact policy at the group level.

Andrew' June 27, 2013 at 12:30 pm

If you steal a car you get evaluated on the individual level (if you believe that cops actually do police work, that is). The question is, are the group level policies helping or perversely making things worse?

Chris Adams June 27, 2013 at 8:49 am

There’s only a conflict if you aren’t reading carefully enough to note that there are two groups being discussed: the top 1% and the much larger number of affluent but not necessarily rich people. There’s no question that the top earners are more productive but it’s really hard to argue that productivity alone explains the massive difference between the top 1% and the rest of e.g. the top 10%, all of whom invest heavily in their children. From a wider prospective, it’s particularly hard to argue that society would not be better off if the people at the top pay taxes at a slightly higher percentage and the results are used to help even out the disparities at the lower end of the scale, moving many people from net-deficit to productive at the expense of slightly reduced top-end luxury spending for a few.

Rahul June 27, 2013 at 9:21 am

Exactly! Hedge fund managers may conceivably be more productive than my neighborhood paramedic; but are they ( $ 500,000 / $50,000 ) times more productive?

Enrichment expenditure may also actually enhance outcomes but the quantum needed is nowhere close to the disparity in incomes.

Andrew' June 27, 2013 at 9:51 am

My high school graduating class had 3 people in the top 1%.

I think you need to split out an additional category. The 1% as political campaign slogan that includes people you probably know personally and the folks for whom the accusation of “ill-gotten wealth” is a tautology.

Dangerman June 27, 2013 at 8:55 am

“or willingness to cut ethical corners of one variety or another.

I’m pretty sure this IS a form of increased productivity.

Scott Lange June 27, 2013 at 9:07 am

How do you get to be a “public intellectual” without basic reading comprehension skills? Chait never says wealth and productivity are completely unrelated or uncorrelated. Alex contrasts Chait’s quote saying there are “lots and lots of ways that a person’s income does not measure his contribution to society” with Alex’s paraphrase of Chait that “greater productivity is an important explanation for inequality,” but there is no contradiction there at all. In the first quote, saying there are lots of ways in which income does not measure contribution plainly implies that there are some ways in which it does. Further, in the second paraphrasing quote, even Alex says productivity is AN explanation for inequality, not THE explanation for inequality.

Alex tries to characterize Chait as contending that skills, intelligence, and productivity have no connection or correlation at all to wealth/income. Chait plainly didn’t say that, and plainly wouldn’t say that since it would be an absurd position to take. For shame.

Steve J June 27, 2013 at 1:22 pm

This is obviously true. It is surprising how far people will twist things to defend Mankiw’s paper.

Andrew' June 27, 2013 at 9:09 am

Seriously, why is this so hard?

Do any non-doctors here have ANY idea what doctors go through? They are lucky (only) in the sense that society has provided them the opportunity to bust there ass for a highly specialized and remunerative career (partly because it is so competitive). I can’t stand the fockers, but I don’t envy them.

Andrew' June 27, 2013 at 9:12 am

Thought experiment, do taxes increase the productivity of those the benefits go to in a non-zero-sum/winner picking way? If resources allocation always picks winners, how could it?

mw June 27, 2013 at 11:10 am

There are 0 doctors in the Forbes 400.

Cliff June 27, 2013 at 12:30 pm

But quite a few in the top 1%

Andrew' June 27, 2013 at 12:36 pm

And a crap ton aren’t white males

JWatts June 27, 2013 at 3:59 pm

There are 0 doctors in the Forbes 400.

Dr. Thomas Frist’s net worth grew $1.6 billion in the past year … . #92 Forbes 400

http://www.forbes.com/profile/thomas-frist-jr/

Brian Donohue June 27, 2013 at 4:21 pm

Amen.

buddyglass June 27, 2013 at 9:23 am

I’m not one of the 1%, but I might be one of the 10%. Or maybe one of the 15%, depending on what metric you use. I’m highly educated and of above average intelligence (again, depending on what metric you use) and I’ve worked in software development for the last 14 years. I have serious doubts about how much I’ve added to the economy over that period. Many of the products I’ve worked on ended up (in my opinion) as steaming piles of crap. People paid money for them, but I’m not convinced those purchases didn’t actually present a negative value proposition. At least one of the start-ups I worked for ended up closing its doors after blowing through a bunch of investor money. One team I was part of worked on a competitor to Square’s mobile merchant offering for a year and a half and never got anything to market. We did draw a paycheck over that period, though, again thanks to investor money.

I often wonder whether my son’s elementary school teacher, who is compensated at about 1/3 the rate I am, doesn’t have a significantly larger positive impact on U.S. prosperity than I do.

Andrew' June 27, 2013 at 9:47 am

I think what you are asking is whether the trial-and-error sector is more productive than the rote sector. As I keep telling my wife and anyone else, what the education system does is take a kid who is ready to learn X, presents them X, and then takes credit for them learning X. Some teachers do a wonderful and unenviable job of this. I don’t have a problem with the individuals.

Ricardo June 27, 2013 at 12:47 pm

buddyglass,

That’s not your call. If other people are telling you (by paying you!) that your marginal product is X, then the best available estimate of your marginal product is X. Over a 14 year period you can expect mean reversion to smooth out any errors that might have been made in assessing your marginal product. (Exception: maybe those errors were biased. But then you’d have to tell a story about why.)

You didn’t deceive your employers; you told them what you’d give them, and they said okay, we’ll pay you X for that. You did, and they did. Okay, so now both of you think that X was too high. But at the time, that was the best available estimate. What is the alternative?

JWatts June 27, 2013 at 4:01 pm

What is the alternative?

A governmental wage boards that fairly sets wages for everyone in the US, of course.

Ricardo June 27, 2013 at 5:05 pm

I honestly can’t tell whether you’re being sarcastic!

buddyglass June 28, 2013 at 12:54 am

I’m certainly not trying to paint myself as guilty of deception. If anything it’s just a mis-allocation of resources by investors and, in some cases, by the customers who purchased a product that was of questionable benefit.

Steve J June 27, 2013 at 1:46 pm

Another obvious point that seems to escape most people on here. It is much easier for people higher up the pyramid to have negative productivity. The easiest example is the financial industry. If those guys were paid based on beating indexes (alpha) rather than total returns (beta) very few would be in the top 1%. But the market is always right…

JWatts June 27, 2013 at 5:45 pm

It is much easier for people higher up the pyramid to have negative productivity.

Which drives their salary up of course! Since you don’t want to hire someone that is going to be a negative, you’ll pay a lot for a proven asset.

Assume you have a reasonably competent CEO, that has been successfully running the company and the company currently earns $1 billion in profits. Now assume he asks to be paid $25 million per year, even though previously he was only making $5 million per year.

Would you agree to his insane demands of a 5x jump in salary? Or would you start looking for someone else willing to work for $5 million? It’s a reduction in profits of 2% for a low risk option.

Steve J June 27, 2013 at 7:20 pm

“Which drives their salary up of course!”

I am not going to argue that the people at the top of the organization deserve less than those at the bottom. I will argue it is both harder to measure productivity at the top and that there is less competition for the jobs. Compare the financial industry and professional sports. My opinion is football players are much more deserving of their compensation than hedge fund managers.

Seth June 27, 2013 at 2:50 pm

Did any successes learn something from your steaming piles of crap? Sometimes figuring out what doesn’t work is valuable to society, even though it could be costly to the people funding it.

buddyglass June 28, 2013 at 12:56 am

Maybe. On a personal level, I feel like I’m better at what I do than I was 10 years ago. So I learned something, at least.

Eric Rasmusen June 27, 2013 at 9:35 am

The most productive employees are paid too little, including the most productive CEO’s.

An employee is paid his expected productivity. It is hard to tell productivity, especially for high-income jobs. Thus, half the bottom managers are paid too little, and half too much. Or, more accurately, the bottom 10% is grossly overpaid, the middle 80% paid about right, and the top 10% grossly underpaid. The top 10% do get promoted. At the next level, most having “reached their level of incompetence”, the pattern repeats. Eventually the creme de la creme become CEO’s— where it repeats again. If it repeated often enough, we’d discover each person’s true ability— but we are mortal, and an accurate eulogy is no great help to the economy.

Thus, for all but the last 5 years of his life, the most productive person is paid less than his value to his employers— and to the economy. To be sure, it is still true that on average executives are paid exactly what they’re worth—- but that’s because the less productive ones are overpaid.

The ideal contract for efficiency might be one like in the Parable of the Talents, where the Master takes away the one talent of the risk-averse servant and gives it to the smart servant who already is being paid the most. If managers don’t know their own abilities in advance, however, which is true (many don’t realize how bad they are even ex post), then the current system provides useful insurance. I think Professor Holmstrom may have written on this years ago.

Of course, many large fortunes are made by being equity residual claimants rather than employees, but the same unfairness is present there. The entrepreneur needs capital, and he can’t get it until he’s demonstrated his ability. My Parable of the Talents contract is actually used though, because the contract is that the entrepreneur puts up some of his own money and loses it if he turns out to have low ability, whereas the high-ability entrepreneur gets a higher profit rate on the capital he borrows. The PT contract is limited by the bankruptcy constraint, however: once the entrepreneur has put up 100% of his wealth, he can’t post any bigger bond to demonstrate his ability.

There are no doubt tax implications to all this, but they will have to wait for another day. I’ve posted this on my blog at http://rasmusen.dreamhosters.com/b/2013/06/why-the-rich-are-underpaid/ so I can remember it.

Popeye June 27, 2013 at 10:05 am

Why is it so hard to measure productivity from a payscale point of view, but easy to measure it from a promotion point of view?

To extend this logic, if promotions are based on perceived productivity, and perceived productivity is a random variable centered around actual productivity, then the people who are promoted are overestimated (and probably overpaid as well), even though they are better on average than those who do not get promoted.

Ricardo June 27, 2013 at 12:49 pm

Doesn’t the Peter Principle say as much?

Tom West June 27, 2013 at 11:57 am

An employee is paid his expected productivity.

In the economic equivalent world of spherical cats moving in vacuums, you’re paid your replacement cost. If you alone have a valuable skill, and there’s one more opening than people who possess that skill, you’re paid your MP. If there’s one less job opening, you’re paid a subsistence wage.

The fact that when minimum wage goes up, job losses are pretty minor indicates that most minimum wage earners are paid less than their MP.

Productivity and wage have a non-zero correlation, but it’s a *looong* way from 1.

Chip June 27, 2013 at 9:56 am

What’s the argument here?

We can’t determine with precision whether a free person is being accurately rewarded for their work by another free person, so the government needs to step in and reward and punish with even less accuracy?

Hazel Meade June 27, 2013 at 11:30 am

The rich-white-guy monopoly on the CEO market is charging an unfair price for CEOs.

Otto Maddox June 27, 2013 at 12:16 pm

I had the impression all of this was leading up to some sort of new income redistribution scheme.

derek June 27, 2013 at 10:03 am

I don’t really see how Tyler’s criticism of Chait works. Mankiw claims that rich people are rich because they are productive. Chait expresses doubt that the wealth of the top classes (particularly the tippy-top, as noted by many other commenters) is an accurate reflection of their productivity. Chait further stipulates that even if Mankiw was right, this would be undesirable, basically for utilitarian/fairness reasons. Anyone care to enlighten why I am wrong?

Andrew' June 27, 2013 at 10:23 am

Okay, then why can’t Alex disagree with Chait?

Warren Buffett, the guy who everybody loves for his $100k salary and same (upgraded) house and eating double-cheeseburgers said something to the effect of (can’t find the source offhand) “It cannot be overstated the importance of who is the CEO.” To me, that says that getting it right is worth getting some things wrong along the way.

derek June 27, 2013 at 1:58 pm

I think you are misunderstanding my complaint. I disagree with Alex that Chait’s argument contradicts itself. It’s not so weird to say something like, “Even if I were to cede this point, which I do not, I would still disagree.” That’s what Chait is saying, and Alex, to me, is failing to comprehend this.

B.B. June 27, 2013 at 10:21 am

Slow down, you go too fast.

Consider this simple model. Everyone in society gets an “endowment” from Heaven, equal for all, that allows a lower middle class standard of living. Casinos are legal, and regulated to guarantee honesty. There is rational expectations concerning the probabilities of games of chance. A subset of the society goes to the casino and gambles. The losers end up poor, the smaller number of lucky gamblers end up rich, in the top 1%. People are willing to gamble and accept odds of poverty to have a chance to be rich. No one is forced to gamble. The voluntary and rational decisions of the subset raise inequality in society.

Is there a problem with the inequality? Should we tax the top 1% and subsidize the poor? After all, the rich aren’t more productive or necessarily better people, but just were lucky.

Even if inequality is based on nothing more than luck, there is no obvious case for taxing and redistributing. The rich did not “earn” their wealth in any economic sense, but they got their wealth through risk taking with willing partners. Only if there was dishonesty in the game could one build a case for redistribution.

Tom West June 27, 2013 at 12:11 pm

Sure there’s a case. Society is constructed to make people happy. If because of this system the majority are unhappy, then in a democracy, there’s every case to make changes that will make the majority happier. Let’s remember that the system exists to serve the population, not the other way around.

In the end, society is mostly about trade-offs between making the majority happier vs. the loss of rights to the minority. The moral underpinning about “deserts” are just weapons in both sides arsenal, to be used as necessary.

Yancey Ward June 27, 2013 at 10:26 am

Empirically, it appears that Chait is overpaid.

Rich Berger June 27, 2013 at 10:36 am

Certainly his contribution to social value is negative.

Ricardo June 27, 2013 at 10:43 am

It’s as if Mankiw said, “in general, women prefer taller men to shorter men,” and Chait replied: “that’s totally untrue! I know a couple where the man is actually shorter than the woman.”

Yancey Ward June 27, 2013 at 10:49 am

We have a winner.

wtf? June 27, 2013 at 2:31 pm

For what category? Most broken analogy?

Ricardo June 27, 2013 at 3:56 pm

Mankiw: “My own reading of the evidence is that most of the very wealthy get that way by making substantial economic contributions, not by gaming the system or taking advantage of some market failure or the political process” (p. 17).

Chait: “Paris Hilton.”

Sam June 27, 2013 at 10:52 am

Especially biting as Mankiw is very tall!

Andrew' June 27, 2013 at 11:20 am

Taller people get paid more, right? So, we could charge taxation by the inch. On the other hand, I have a secret belief that there is a normal height provided by genetics if someone gets the optimal developmental environment and sub-optimal environments rarely add height.

dead serious June 28, 2013 at 9:27 am

Making it all the more awkward since his lips are constantly pursed right up against the asses of the uber-rich.

David June 27, 2013 at 11:13 am

Chait is taking Mankiw to be committed to more than an imperfect correlation between productivity and income–for example, by (allegedly) using “productive” and “rich” interchangeably. Having not read the Mankiw, I have no idea if that is fair, but it is pretty obvious that Chait means to be denying only that the correlation is very close to perfect. So there is no contradiction when he also agrees that skills (including one’s that rich kids get an upper hand at developing) play a role in contributing to high income later in life.

Honestly, Alex’s criticism of Chait seems willfully dense to me. Maybe it is just easier for me to understand Chait’s thinking because I agree with it, but I find it hard to imagine being unable see how Chait’s statements are consistent.

Now that I have written this, I see that Scott Lange made the same point at 9:07 am.

Steve J June 27, 2013 at 1:56 pm

“Alex’s criticism of Chait seems willfully dense to me”

The entire Mankiw piece is willfully dense. How do we reward things that are hard to measure? Do we recognize great art when we see it? In the long run the market does work. Too bad we get paid in the short run.

Scott Lange June 27, 2013 at 2:20 pm

Right, David. I mean, its either horrific reading comprehension, or deliberate deceit.

Hazel Meade June 27, 2013 at 11:17 am

I think there’s another angle you could take. The rich aren’t that much more productive than the poor, they just happen to have jobs that allow them to exercise greater productive power. There are only so many jobs for CEOs in the world. The few people that get them might be the best CEOs on earth, but only be marginally better at being CEOs than others. I.e. you are 10% better at being a CEO , but you get paid 10x as much as the guy who just marginally loses out at being a CEO.

On the other hand if there is that much competition in the labor market for CEOs then the pay rate of CEOs should fall, right?
So is the fact that CEOs are highly paid evidence that CEOs are more productive, or is it more that capable executives are rare and in high demand? I.e. this isn’t necessarily a signal about “productivity” it’s a price signal telling the labor market to produce more people who are capable executives.

mw June 27, 2013 at 11:25 am

Which will be tough because they’re generally the rich white male children of rich white people, and how many kids can those people really produce?

Hazel Meade June 27, 2013 at 11:27 am

Is there some reason why only rich white males can grow up to be executives?

mw June 27, 2013 at 11:31 am

According to Greg Mankiw, no, it’s just coincidence.

Andrew' June 27, 2013 at 12:34 pm

It MUST be racism.

Where do we sign up for the racism?

mw June 27, 2013 at 1:14 pm

No as I said it’s all coincidence. EVERYTHING is a coincidence. That increased inequality (across all demographic distributions to which we have access) produces increased inherited inequality is coincidence. That rich kids who seem no smarter than poor kids but have much more enriched upbringings which we can show in MICE for f**k’s sake to make them smarter, is also just coincidence. And that women get paid $0.91 per male $1 of the same work, and then ALSO turn out to be all of the Forbes 400 is coincidence.

It’s one big cosmic coincidence designed by liberals to shake your pious faith in the existence of a free market. But you won’t fall for it! Stay STRONG!

prior_approval June 27, 2013 at 1:16 pm

‘Where do we sign up for the racism?’

No need to sign up for it – at least if you are born in the Commonwealth of Virginia, you got the race classification upon birth. Previously based upon that scientifically based one drop rule – though that has apparently changed in the last 5 years or so.

Which shocks Germans no end, by the way, leaving aside the reality that according to the laws in force at the time my birth, my race legally determined who I could marry in the Commonwealth.

What is surprising is how it doesn’t shock Americans to be classified by race at birth, at least in those states that classified babies into such categories. Except the racists – they appreciate having official documentation to point to.

Cliff June 27, 2013 at 1:34 pm

The racists being the recipients of affirmative action?

Hazel Meade June 27, 2013 at 4:03 pm

Now using straight free market theory, if we implemented policies in public schools designed to produce more capable executives, then CEO salaries ought to fall, right?

Maybe the problem is that our public schools are really, really shitty at teaching people the kind of skills they need to be leaders. It’s not that CEO are necessarily smarter, and it’s not that public schools aren’t teaching math or ar lacking in music and art classes, public schools teach conformity and following orders. They do not teach people how to lead or think independently.

anon June 27, 2013 at 9:03 pm

What is surprising is how it doesn’t shock Americans to be classified by race at birth

Just check “Other”

Careless June 29, 2013 at 10:48 am

And that explains how the public schools rich kids go to produce leaders how, HM?

Seth June 27, 2013 at 2:53 pm

Because they want to.

Andrew' June 27, 2013 at 11:24 am

I actually started to read Chait’s thing. After saying Harvard employs Mankiw just because he’s a political hack (wtf?) he drops this one “It’s almost impossible to find empirical support for debt-financed tax cuts.” Wtf?

MPS June 27, 2013 at 11:31 am

I think the proper view here is that an individual’s productivity depends on the broader collaboration of society. This is why it’s OK to tax them more, if deemed necessary.

For example, a CEO makes decisions that could add enormous value to society. That’s because the CEO is in charge of a lot of people, being funded by other people. The CEO by herself cannot accomplish nearly as much as she can being in charge of a large company.

Productivity can be more circumstantial than that. Inventing new, useful pharmaceuticals is a very productive activity, but largely because the govt issues patent protections. If the there were no IP protections (or if IP protections were significantly weaker) then all sorts of highly productive people would suddenly become unproductive. It has nothing to do with how hard they work or how clever they are; it’s just their work would have much less value.

All sorts of workers in the US are more productive than their counterparts elsewhere, and again it has nothing to do with how hard they work. It’s because capital investment in the US gives them access to tools that allow them to produce more with less labor.

A McDonald’s worker in NYC is more productive than a McDonald’s worker in Scranton. They’re both doing the same job in the same country! But NYC McDonald’s services more people (due to larger population density), and/or services people whose time is worth more (due to city wealth), and that makes the NYC McDonald’s worker more productive. (Which is why he gets paid more.)

The flaw with Mankiw’s reasoning is to think that productivity equates with merit. This is a *moral* position steeped in all sorts of social context. As a moral position, he’s allowed to take it. Many of us think it is better to take a position that “merit” should be determined by creating incentives to increase some utility function. Economic theory tells us (I believe) that this approach will actually closely connect productivity with merit, but there are other considerations, and I believe these other considerations are what encourage things like progressive taxes.

Hazel Meade June 27, 2013 at 4:18 pm

I think this is right, and I was thinking along the same lines. But then you also have to consider how salaries are a price signal to the labor market. So what we’re looking at isn’t *just* that the top 1% are more productive because they have access to certain tools, but that there is a high demand for people with the skills to use those tools effectively, which drives up salaries for those people. There’s a lot of discussion in society about the shortage of STEM workers, but STEM workers make up more like the top 10%, whereas the top 1% or 0.1% are made up of people in finance and executives. Certainly, those people probably know some math, but what they really have is leadership ability, management skills, and breadth (they have to manage information coming from different domains effectively).
I don’t think any of that gets taught in public schools. “Leadership skills” is something that sounds like it came from the Boy Scouts or the first thing to get cut from the public school curriculum back in 1965.

Rich Berger June 27, 2013 at 11:41 am

So in a largely free market, some end up with much more money because others have voluntarily given it to them. But Chait and other like him, don’t think that’s fair, so they want to substitute their judgement for that of the market (which is just the collective result of individual actions). First, why should he rule us? Second, any such massive scheme of judging fairness will sharply reduce freedom and the size of the pie that gets “distributed”.

Some will object that the market is not free and I agree if you mean that political power has allowed connected participants to game the political system. By all means, let’s reduce that. But I know they mean more than that – they just think it’s not fair. So they want to dismantle a system that has lifted billions from poverty and propelled them to unimagined levels of prosperity for some vague idea that a “fairer” distribution can be obtained.

Obsession with fairness and envy of those wealthier is just the symptom of small, embittered minds. It is one of the key complaints of the perennially aggrieved, and these people will never be happy or satisfied until they make others suffer.

Tom West June 27, 2013 at 12:16 pm

First, why should he rule us?

Because he has the votes?

Ricardo June 27, 2013 at 12:57 pm

So if we all vote to crush you under a pile of stones, it’s okay?

Jared June 27, 2013 at 11:56 am

“Where did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income”, by Ian Dew-Becker and Robert J. Gordon, September 8-9, 2005

http://zfacts.com/metaPage/lib/gordon-Dew-Becker.pdf

“We argue that economists in their explanations of growing income inequality have placed too much emphasis on “skill-biased technical change” and too little attention to the “economics of superstars,” i.e., the pure rents earned by the top CEOs, sports starts, and entertainment stars. This source of divergence at the top, combined with the role of deunionization, immigration, and free trade in pushing down incomes at the bottom, have led to the wide divergence between the growth rates of productivity, average compensation, and median compensation.”

“To be convincing, a theory must fit the facts, and the basic facts to be explained about income equality are not one but two, that is, not only why inequality rose after the mid-1970s but why it declined from 1929 to the mid-1970s. Three events fit neatly into this U-shaped pattern, all of which influence the effective labor supply curve and the bargaining power of labor: (1) the rise and fall of unionization, (2) the decline and recovery of immigration, and (3) the decline and recovery in the importance of international trade and the share of imports…. Partly as a result of restrictive legislation in the 1920s, and also the Great Depression and World War II, the share of immigration per year in the total population declined from 1.3 percent in 1914 to 0.02 percent in 1933, remained very low until a gradual recovery began in the late 1960s, reaching 0.48 percent (legal and illegal) in 2002. Competition for unskilled labor not only arrives in the form of immigration but also in the form of imports, and the decline of the import share from the 1920s to the 1950s and its subsequent recovery is a basic fact of the national accounts.”

Floccina June 27, 2013 at 12:08 pm

We all know people in our field who earn too much, or too little, because of social connections, or race, or gender, or luck, or willingness to cut ethical corners of one variety or another.

Really? Not me. Am I the only one. It seems to me that those willing to cut ethical corners of one variety or another mostly end up paying for it. Sometimes I think you took that risk for that small gain.

Andrew' June 27, 2013 at 1:12 pm

No, it’s everybody. He just has to say that. We also have to gloss over the fact that almost all of us get roughly the same pool of education so we have to blame Summer camps or some other nonsense.

momotov June 27, 2013 at 2:34 pm

Wait we all get roughly the same education? I went to public school, then a gifted school, then a rich-person private school, then an Ivy League school.

No, wait. You’re just speaking nonsense again.

Cliff June 27, 2013 at 3:31 pm

And did you actually learn anything useful at any of those schools?

asdf June 27, 2013 at 2:26 pm

I know lots of people who have done unethical or illegal things, gotten away with it, and become rich.

lolotov June 27, 2013 at 2:41 pm

You don’t know anyone who’s gotten lucky or unlucky?

You don’t know anyone who hasn’t been helped by social connections?

What field are you in? You’re not poor, or you’d know people who are unlucky. So you’re rich, but your career is not finance, because you’d know socially connected and lucky and unlucky people (I know many). I’m also guessing it’s not law, or politics. Maybe you’re a doctor, but that would mean you haven’t met many other doctors, nurses, or administrators in your career. Wait, I got it. You’re a small business owner. Not completely self-financed, because that would imply you’re lucky or socially connected. Did you get money from strangers only? Maybe you saved money for years. If that’s the case, congratulations, and you’ve earned my admiration. But just FYI, other people in your field didn’t do it that way.

Floccina June 27, 2013 at 3:18 pm

I meant that I do not personally in my field (computer software) know of anyone who got ahead by cutting ethical corners of one variety or another.

I am part owner of the company that I work for BTW. At 29 years old about 7 years out of college I was working a restaurant making little over minimum wage but yes I am now rich. I was lucky enough to be born in the USA and I guess that I was lucky enough to have good business partners and a wife who did not divorce me or blow lots of money. But again I was only referring to success through unethical behavior.

asdf June 27, 2013 at 7:33 pm

“I meant that I do not personally in my field (computer software) know of anyone who got ahead by cutting ethical corners of one variety or another. ”

Man you’ve led a blessed life.

Floccina June 28, 2013 at 2:07 pm

Interesting asdf, so you know many people who are successful but would not have been had they been more ethical.

Steve J June 27, 2013 at 2:23 pm

“It seems to me that those willing to cut ethical corners of one variety or another mostly end up paying for it.”

Trying to reconcile this statement with the concept of a “good” salesman. We generally call a salesman good when they sell more of the good or sell the good at a higher price. If the salesman is selling used cars we often consider the techniques of a good salesman unethical. My general impression is that good salesmen in any field would also be good at selling used cars…

Floccina June 27, 2013 at 3:25 pm

In my experience those unethical salesmen mostly loose out in the long to those who know their product well and deliver constant good value (and they tend to blow there money and often end up divorced because what you are work you generally are at home). Not all end up badly by many. Even in used cars I buy from the dealer at this link (www.secars.com) and they are killing the other local dealers by giving a good value consistently. Check their web page if you do believe me.

Steve J June 27, 2013 at 3:44 pm

Still trying to understand what makes a good salesman. The “good” salesman succeeds in getting the buyer to pay more for the same product than the “bad” salesman. How do we know when the good salesman is being ethical? Can the salesman be too good?

Cliff June 27, 2013 at 5:06 pm

The good salesman identifies people who can benefit from their stuff and ways those people can benefit. So they sell more and at higher prices, and their stuff is used more and does more good. (theory)

Steve J June 27, 2013 at 7:59 pm

“The good salesman identifies people who can benefit from their stuff and ways those people can benefit.”

What you are describing is generally called “pre-sales” and is certainly an easier to position to look upon favorably. But the “real” salesmen are only called in after the potential chump, or rather client, is identified. Possibly most successful salesman use a win-win approach but that is not my impression.

JWatts June 27, 2013 at 5:58 pm

The “good” salesman succeeds in getting the buyer to pay more for the same product than the “bad” salesman.

I’m guessing you’ve never been in sales. The “good” salesman is almost always the one who sales the most of a product. Quite often the “good” salesman will have a lower margin per sale, but a drastically higher sales rate.

Steve J June 27, 2013 at 7:44 pm

“I’m guessing you’ve never been in sales.”

That is true. However I would claim the concepts are fairly simple (but not the execution – bullshit is an art). So you are claiming less profitable salesman are preferable to more profitable? I expect people who sell at a loss will not remain around long. In most negotiated sales it is profitability that is more important over volume. When it is in the salesman’s best interest to “screw” the buyer ethical concerns are not highest priority.

JWatts June 28, 2013 at 12:01 am

I realize math is hard, but surely it can’t be too difficult to understand that a salesman with a somewhat lower margin but a drastically higher sales rate is more profitable, not less profitable?

Steve J June 28, 2013 at 1:04 am

“a salesman with a somewhat lower margin but a drastically higher sales rate is more profitable”

At a simple level I agree. For more complex products such as a loan or software services (things I am more familiar with) I am not sure. Profitability in those cases can be revised later.

The point here is mainly about the ethics involved in sales. The salesman often has incentives not just to sell the product but to sell the product at the highest possible price. Don’t incentives matter?

Floccina June 27, 2013 at 3:05 pm

Why would the children set to inherit more than (let’s say) $10 million study or work at all?

prior_approval June 28, 2013 at 3:50 am

But their wealth makes them productive, as in the framing terms of this discussion – even without study or working, inheriting money seems to be an inherent property of being considered productive.

Jacky Wong June 27, 2013 at 11:18 pm

Not at all inconsistent if you think (i) signaling theory and (ii) tournament theory both holds, at least to some extent.

People with the high-paying jobs, especially those in finance, are not more productive than those who failed to get the jobs. They merely won the race to get the jobs. As a believer of efficient market, I think you can agree that a random person doing a fund manager’s job wouldn’t be less productive. Knowing this, the rational thing a rich parent will do is to increase the chance his children will win the race in getting these lucrative jobs. Building connections is one way. Knowing how to act/talk like these high-paying people is another. Doing all these are beneficial to these children (in terms of potential future income), but not necessarily means they are more productive.

Seth June 28, 2013 at 1:14 am

I think luck plays a part in success, but that’s a terrible reason for the less lucky to take more from them. Sure, I was lucky that I had good parents who read to me at night. Does that mean I should have been made to give some of my A’s to some of the less lucky?

As long as you allow luck to be a justification to help yourself to others’ things, anything can be considered lucky.

If you don’t like rent-seeking, it seems you should advocate getting rid of it rather than trying to offset it through policy.

Melissa June 28, 2013 at 3:08 pm

If we are to look at this in the context of international economics, the same argument can be made for various firms. The most productive firms output more and reap more financial gain because of their efficiency and ability to export, whereas the less productive firms stay in the domestic market because of their inefficiency. The productive firm’s efficiency is a direct result of its investments, its ability to differentiate itself from other firms, and among other things its comparative advantage, thus leading to inequality among firms internationally. In the case of the “One Percent,” productivity and investment also play a big role. Mankiw’s response, “A huge portion of the achievement gap between poor and nonpoor children is attributable to summer vacation,” makes sense because during the summer children’s scholastic performance can worsen, similarly with firms that do not continue pushing frontiers and improving.

Dominic June 29, 2013 at 12:43 pm

Seth, you’re relying on a false analogy. Grades are nothing more than a convenient metric for measuring academic performance. If getting a C on your exam meant you couldn’t have anything to eat that day, then yes, those who got As would have a moral obligation to give some of their good grades.

Phil Goetz July 8, 2013 at 8:41 pm

“But do you really think that a CEO at a top 350 firm doesn’t have as much effect on the performance of a company as 273 average workers?”

This strikes at the key way people are talking past each other in this conversation: Say the question is, “Does a CEO making 273 times the salary of a worker deserve it?” But people mean different things by the word “deserve”:
– A CEO deserves his salary if his actions have increased profits by more than his salary.
– A CEO deserves his salary if the supply/demand curve for CEOs does not provide the firm with any CEO #2 who could be paid $x less, and produces profits of $p less, where x > p
– A CEO deserves his salary if he works 273 times as hard as the average worker
– A CEO deserves his salary if he is 273 times as smart as the average worker

My thought is that the word “deserve” doesn’t belong in economic discussions of supply and demand. The actions of a CEO are multiplied in their impact by the workers below her, and that multiplicative affect makes even a small increase in CEO performance worth a great deal of money to the company. But this has nothing to do with the CEO “deserving” the money. Even if it did, you would have to prove that everyone had equal access to CEO jobs regardless of race, sex, or parental income in order to say the financials mean CEOs “deserve” their income.

It’s very hard to have this discussion without most people jumping to talking about what people deserve, rather than what is economically optimal. You need to make it clear that you’re talking about being economically optimal. That means that you CANNOT use any results to make moralistic claims about the virtues of rich people.

Unfortunately, the first thing you need to do is establish what you mean by economically optimal, which requires weighing the utility of individuals in some way. THAT is where “deserving” comes into economics. If you weigh each person’s utility function according to their contribution to the economy, you are making a moral judgement. If you weigh each person’s utility function equally, that’s a different moral judgement. Making the moral judgement that people who contribute more deserve more leads to higher “socially optimal” CEO salaries, because company profits are paid primarily to rich (more deserving) people, and hence count more, on a per dollar basis, than employee salaries. If you fail to clearly distinguish when you’re talking about morality and when you’re talking about optimal distributions, as everyone in this discussion has done so far, you will plug in statements about morality where statements about optimality belong, and vice-versa, and end up making circular arguments.

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