John Cochrane on inequality and growth

Though he is quite polemic, too polemic I would say, he is largely correct:

Oh please. Yes, the problem with America is… our darn national thriftiness?

Anyway, can’t we do better than spewing some half-remembered undergraduate course from the mid 1970s in which a sleepy professor with long hair and bell bottoms pushed around IS LM curves and talked about “demand” and “marginal propensity to consume” a lot? Didn’t Milton Friedman demolish the whole concept of “marginal propensity to consume” 70 years ago? Is this it for the connection between inequality and growth?

Most of all, if the reason that inequality is bad for growth is that it leads to insufficient consumption and lack of demand, then that can easily be addressed in the same Keynesian framework with lots of stimulus spending. If you play the game, it seems to me you have to play by the rules. Even if you accept the diagnosis, then you do not accept the conclusion that very high — and very distorting — taxes and transfers are the best remedy. Unless… you really don’t believe the mechanism, or the connection to growth, and this is all rhetoric in favor of taxation for other reasons. It is interesting how the diagnoses seem to follow the prescription.

There is more here, polemic throughout, on the recent S&P study, which doesn’t seem to hold up.


Now we're getting somewhere. I vigorously tip my hat to John for the polemics and Tyler for the 'hold the front page'.

Because. The truth is that which advances the [fill-in-the-blank].

Darn right. Americans are materialistic, over-consumptive automatons willing to destroy the world with their pathetic, insecure need to Keep Up With The Joneses.

Unless of course you need ammo in your bid for more statism. In that case, only the Government can stimulate the economy!

Ad hominem. Piketty's now famous thesis for ever rising inequality, r > g, has not one but two variable, r and g. As Cowen pointed out in his interview in the NYT, r has been falling for 30 years, or about the same period of time inequality has been rising. Why is that? Are low g, low r, and rising inequality a mere coincidence? Does a low r induce owners of capital to prefer speculation and greater risk, adding to financial instability? Does the "sleepy professor with long hair and bell bottoms" know the answer?

Wealth inequality is an inevitable byproduct of the economic value rich people create. In a free market , resources will go where they are most economically useful, without some bureaucrat or leftist trying to spread the worth under a mistaken, detrimental effort of trying to stimulate the economy that will only backfire.

Is income inequality inevitable to the degree that 50% of the population can not live on their income? How about just 20% not being able to live on their income?

When society was based on hunter-gatherer and later farming, subsistence for 100% was possible as long as drought, flood, war, climate change did not occur because the land sustained you. In the economic definition of work/labor, no one needed to work or labor to survive. Unemployment could be 100% - no one needed a job or wage income.

The point when economists lost sight of the society in which Locke and Adam Smith lived, the economists declared that the land should not be in the hands of the people who live on it, but needs to be taken for use by the economy. The people thus were forced to be factors in the economy. But economists still viewed them as people living on and off the land where work was not required - if you are not paid by someone else, you are not working. That's why it is said that a billion people live on $2 per day - the food they harvest from their land and consume is not counted as part of the economy. The isolated tribes in the rain forest live on $0 per day.

You make the leap from $0 per day for the isolated tribe into being in poverty, except they are fantastically wealthy. Thus the reason economists want their land taken away so the lumber sold destroying the viability of the forest, the minerals mined and pure water polluted - that is wealth creation, and those isolated tribes can be better off working for a time for $5 a day destroying their land.

Yeah right, hunter-gatherers kived a comfy life, tht's why they died before 40

THIS is why the reference to global inequality is so relevant to the American inequality discussion. Herein we have Mulp, an inequality warrior, claiming that "50% of the population [US] can not live on their income". One hundred fifty million Americans are shocked to learn that they are dead. 80% of the world is shocked to learn that their income is too low to live on, and they are, in fact, dead.

Here's to the "living wage". Everyone else is dead.

mulp is my favorite deranged commenter. No one else is even close!

I just assumed that S&P threw this together to get off the Administration's enemies-list after the 2011 downgrade.

LOL +1

No LOL +2

Yep, which is why Cochrane is wrong to call it an "awful" document. It's good for S&P which makes it a successful document.

I'd say they finally faced reality that all the things they were blaming on Obama and for causing the lack of growth were false. Taxes are lower than during Reagan's two terms so high taxes is hardly a justification for slow growth if you are blaming high taxes. Regulations are hardly justification if you compare the regulations to those in effect at the beginning and end of Reagan's two terms. Government spending crowding out the private sector when you compare the shrinkage since 2010 with the expansion after 1983.

The one big thing different is the rising income inequality since 1981 especially with the massive increases in debt in all sectors since 1981, until 2009 when the debt in the private sector has shrunk.

When debt is shrinking then consumption must shrink given the use of debt to fund increased consumption since 1980.

Before 1980, government policy required debt for investing in real assets - those who violated such rules were loan sharks and illegal. Part of the enforcement was caps on interest rates which at the highest risk were capped at 12-18% when savings accounts were paying 4-4,5%. Secured debt was capped at 12% for used cars, appliances, and 6-7% for real estate.

Getting government "out of the way" was required to allow incomes to stagnate while consumption soared. Only when the bottom 50% can borrow and spend can there be economic growth, high profits, and lower wages for the masses.

S&P did support this system by giving debt to borrowers, with no income or assets, high bond ratings, and then got criticized for doing so.

I too long for the days when I could get an auto loan for 12%. Those were good times.

Inequality is as much if not more the product of pre-tax policies as taxation and distribution. For example, "too big to fail" policies transfer billions to the financial sector, exchange rate and trade policies make low paid workers compete with foreigners, while licensing laws protect high paid doctors and lawyers from competition, anti-inflation policies slow growth and keeps millions out of work.

You are describing rent-seeking, the good grumpy Professor touches on this:

"A conundrum not yet faced on the left: if rent-seeking is driving inequality, just how is giving the government more power to redistribute incomes, increasing the incentives to rent-seeking, going to help? High tax rates are catnip for tax lawyers, lobbyists, and rent-seekers."

You would think this would be a compelling argument for the progressives to get on the small-government bandwagon, until you realize that they largely consist of the hand-out class, and the Doctor/Lawyer/Financier/Educator class. Oh, and young people, that don't realize what lobbyists actually do.

If educators are rent-seeking, they are doing a horrible job of it!

How so? Upwards of $90k for half a years work, with nothing more than a bogus degree from some crappy education school. Seems like they're doing pretty well to me.

You have no idea what you're talking about. ;-)

Of course, I'd expect an engineer to say that.

Teachers aren't intelligent. See: standardized scores.

Thomas: they have a harder job than you. Guaranteed. We don't attract intelligent people to the field because people like you shit on them.

If you can't do it, teach it. Don't see many teachers leaving the field to become block layers or civil engineers, either. There must be something they like about the profession.

" Upwards of $90k for half a years work, with nothing more than a bogus degree from some crappy education school."

It's impressive how many things you can get wrong in one sentence. Impressive troll, you did get a lot of responses.

Well, that counter argument is a straw man. Redistribution will never work, because the free market will seize it!

You can adapt it to argue against _any_ government activity, ad nauseam. Healthcare? A excuse for doctors to bleed us dry. Education? A subsidy for hippies.

If the problem is too much political/economic power is concentrated in too few hands, the most straightforward way is to redistribute it at the source. The conservative response so far is "this isn't a problem", but work with me here. Assume that inequality is a grave concern. What's the right conservative response?

To stick their head up their arse.

A meeting of minds with the left.

"Redistribution will never work, because the free market will seize it!"

If you think "rent-seeking" equals "free market" you misunderstand everything being discussed.

"If the problem is too much political/economic power is concentrated in too few hands, the most straightforward way is to redistribute it at the source."

I agree but probably not in the way that you intended. If the problem is too much power in the government's hands, which it often is, let's redistribute some of it back to the people and restore freedom of choice.

Power to the people, right on! [Illustrating my impeccable hippie roots.]

It worked fairly well in the US from 1950 to 1980.

Though if inequality is the cause as much as the result, what hope is there for reform?

The legitimacy of many economic policy recommendations is contingent on price serving as an effective proxy for the subjective experience of utility that a transaction nets an individual. The problem with economic inequality is that income effects make this correlation less and less true. IE a rich person can spend a thousand dollars to buy herself something that provides far less utility than the same thousand dollars would buy a number of poor people. I admit that we lack the tools to measure this subjective experience of utility, but that doesn't excuse the use of a proxy that provides, not just incorrect, but systematically incorrect guidance.

One of the better explanations of why income and wealth inequality are real problems.

No, it is an explanation why control of the supply are real problems. Rich people wouldn't pay quadruple prices for housing in coastal cities if there was an ample supply to the demand.

I don't see the price of corn driven up by rich people who would pay high prices for specialty tacos. I pay a very good price for cherries grown locally where the orchardists target the Japanese market for the exquisite and perfect cherry. Those who pursued this market planted trees that produce a large cherry that ripens in August. I had the first ones yesterday. Oddly if you plant a bunch of trees you end up with a surplus over the specific market demand that I can enjoy.

By the way a fellow in the Okanagan who does the same work as I do developed a water chilling system for treating the cherries that allow the preservation and export of this fragile fruit. He developed the equipment, tested it and managed to sell a few, now is selling into other markets in other countries. Those damn rich Japanese! They are taking from the poor, making us all worse off.

It might very well be the case that allocating finite resources towards producing small amounts of particular capital/labor intensive fruit for international markets to satisfy the expensive tastes of a few wealthy people might lead to inferior utilitarian outcomes than producing greater quantities of a more affordable fruit. The difference in utility between a rich person having to settle for cherries grown for cherries grown to maximize yields/hardiness instead of some platonic ideal of cherry is likely smaller than the difference in utility from the less affluent person having no cherries at all.

I don't think it's productive to vilify those who have more resources for their purchases, but I think we can describe a framework where producing goods that cater to the tastes of the wealthy few who develop increasingly particular tastes due to hedonic adaptation might present an inefficient allocation if we are interested in maximizing the subjective experience of utility across a population.

But then don't we turn around and decry the choices the masses make? Ugly consumerism!

Then we tell people they should eat their vegetables. And they really hate THAT!

I understand your point about subjective marginal utility, but it seems like it sets us on a path of nannyism. I'm not a Nudge hater, and it think there is promise in behavioral framing (can I just say, for example, that the 'Truth in Lending' document associated with mortgages is the ONLY relevant document in a sea of legalese?), but heavy-handed crap like no 32 oz fountain drinks?

OK, I skipped over some steps, but this was where your comment led me. I think it's coherent. Maybe not.

I definitely share your skepticism of specific interventions that this sort of 'relative utility' model might lead people too. My skepticism of the ability of markets to measure relative utility does not mean that I think bureaucrats would succeed where markets fail (outside of certain edge-cases). The issue for me is that while we can easily use math to calculate deadweight losses associated with redistributive taxation there also exists a 'decreasing marginal utility of wealth' effect that is difficult (impossible?) to calculate, but psychological research shows that it's quite powerful. It seems to me that a lot of economic research tends to privilege quantifiability over accuracy and this leads to recommendations of less egalitarian policies than would be utilitarian optimal.

we are interested in maximizing the subjective experience of utility across a population.

That is so, so scary. Please take up surfing or knitting or something.

Do you know anything about the fruit market? Do you have some special wisdom to impart other than 'inferior ulterior outcomes'?

These cherries are grown in Creston, and the common cherries that are available early July ripen a week or so later than the Okanagan or Washington State, so they are uncompetitive. These enterprising growers found a lucrative market for a specialty product which generated the cash to build the necessary orchards and other infrastructure to service it. The trees produce more than what the Japanese buy, so I get some.

The cherry production in that valley ( a stunning place to visit by the way ) would not exist except for the very wealthy buying their special products.

And I repeat. The fact that rich people buy this product does not, I repeat, does not 'deny' enjoyment of these cherries to people of lesser means. My argument is that the production would not exist but for these people who pay a premium for it.

The point of a Nudge is that it's done with your foot.

You mean corn that we smug rich people burn in our cars to show we care about the environment, written into law, while the world starves?

"I don’t see the price of corn driven up by rich people who would pay high prices for specialty tacos."

Actually, you do. You see "organic" corn and "locally harvested" corn sold at a higher price because rich people are willing to pay high prices for specialty corn (and tacos, and other things).

So thank you for proving my point!

But you don't have to buy the specialty corn that is more expensive. The organic corn, and locally harvested corn hasn't driven out the commodity corn that feeds millions, nor has it driven up the price.

I would suggest that the small and lucrative markets you describe actually subsidize the commodity production.

Paris Hilton once spent $3200 on a red velvet cake: . So, yeah, you're 100% wrong with your "rich people don't spend more for corn" bullshit.

So did that $3200 cake make it more expensive for you to buy a cake? Do you now have to bid $3500 for a cake for your kid's birthday? I didn't think so.

Crowding out the market, derek.

So someone shouldn't be allowed to sell Paris Hilton a $3200 cake?

Every time someone buys a Ferrari the price of a Fiat goes up. It must be stopped.

That is literally true for $90,000 Teslas in California. The cheap cars purchased by the poor have a tax add-on to underwrite that toy for the rich.

(Please spare us attenuated talk about the environment- if you cared about that, subsidize sneakers and bikes).

Let's not get rid of that tax, but of the free market.

There's your good inequality and your bad inequality. Good inequality is created by entrepreneurs who innovate in societally useful ways. However, make no mistake about it Microsoft and Google are wealth transfers from the middle class to the top .01%. These are good for societally useful economic growth.

The bad inequality comes from rent seeking, crony capitalism, untaxed eternalities, and probably inheritance. I would place most defense spending, most fossil fuel wealth, most financial institution and hedge fund generated wealth (not Vanguard), big agriculture, and Wal Mart type dynasties in those camps. These are bad for societally useful economic growth.

Who exactly owns Google and Microsoft? OK yes Bill Gates is in the top 0.01% but he doesn't own the company any more. I suspect if you really look into it such companies are owned by pension funds, mutual funds and 401K's. Yes this will skew towards the upper middle and upper class but not quite the 0.01%.

Google is controlled by its founders, as far as I'm aware.

Bill Gates started his career profoundly middle class. He built something where people like him could start working, build a product or a market and get wealthy. If he is the poster boy for income inequality, then income inequality people are simply blithering idiots who want to stop innovation and economic growth because somewhere someone will make more money than they do.

Same with Google. Page and Brin were a few short years ago smart kids with no money. Venture capital people study what happened because they were turned down by many as some smart kids with ideas in a crowded market space. They built something again where many people got wealthy either using their products or working for them. I use Google stuff and the money I don't pay Microsoft for equivalent functionality goes into training the people I have working for me.

Sam Walton was not rich, but through business acumen built an empire. Are you suggesting that what he built be sold and taxed? If so you are out of your mind.

Bill Gates is successful monopolist who made billions from taking advantage of network effects. He was able to do so because the US government was willing to prosecute people who used one of the potentially infinite unauthorized copies of his products that could be produced at zero marginal cost. Windows and office were best in class products for much of his tenure, but this is not the reason for their success.

Yawn. Microsoft was a successful business for many reasons in a business that was renowned for short life spans.

'Bill Gates started his career profoundly middle class.'

Only if you define middle class as having this sort of background - 'Mary Maxwell Gates (July 5, 1929 – June 10, 1994) was an American businesswoman. Gates served 18 years (1975–1993) on the University of Washington board of regents. She was the first female president of King County’s United Way, the first woman to chair the national United Way’s executive committee where she served most notably with IBM's CEO, John Opel, and the first woman on the First Interstate Bank of Washington's board of directors. Mary's son Bill Gates is the founder of Microsoft.'

More from the article: "Gates received a degree in education from the University of Washington in 1950. She met and married law student William H. Gates, Sr., at that time. During the early 1950s, she taught school. After her husband co-founded the law practice that became Preston Gates & Ellis in Seattle, Gates turned to a variety of civic activities. Gates' volunteer roles in Seattle and King County included serving on the boards of the Children's Hospital Foundation, Seattle Symphony, Greater Seattle Chamber of Commerce, United Way of King County, and many other nonprofit organizations. She also served as President of the Junior League of Seattle from 1966–1967." Yes, I'm sure the greater Seattle area is much the poorer for the greedy excesses of the Gates family. Just think, if Mrs. Gates hadn't jumped into all this volunteer work, there would have been more reason to expand government!

'Yes, I’m sure the greater Seattle area is much the poorer for the greedy excesses of the Gates family.'

This is bizarre - why would pointing out the Gates family connections (one of which was central to the success of Microsoft), and their not exactly middle class status at the time William Henry Gates, III was born or making his first business connections, makes either the family greedy, or Seattle poorer, escapes me completely.

Keep going prior, you will end up in the same place as a former NDP leader who defined the rich as anyone making over $40k.

Well, here is another middle class American and her father, much like Bill Gates' mother -

'In 1937, while Rodham was making a sales call at a textile company, he met Dorothy Emma Howell (1919–2011), who was applying for a job at that company.[2][5] After a lengthy courtship, they married in early 1942.[2] Rodham enlisted in the United States Navy, where he became a Chief Petty Officer stationed at the Great Lakes Naval Station, performing training duties for sailors headed for the Pacific Ocean theater of World War II.[2]

After the war, he began what was to prove to be a very successful career in the textile supply industry, starting with Rodrik Fabrics, a drapery fabric business located in Chicago's famous Merchandise Mart building.[2] His company made drapes and window shades; his customers included offices, hotels, airlines, and theaters.[4] He later opened a fabric print plant building on the North Side.[2] Rodham tried politics once, running for Chicago alderman as an independent in 1947; he lost badly to the Richard J. Daley political machine with which he was hoping to ingratiate himself.[4]

The Rodhams had three children: Hillary (born 1947), Hugh (born 1950), and Tony (born 1954). In 1950, they moved to the more affluent Chicago suburb of Park Ridge, Illinois.[2] The family still maintained ties to Scranton; all three children were christened there, and they spent summers at a cottage overlooking Lake Winola, located in Overfield Township in the nearby Pennsylvania Pocono Mountains,[2][5] that he and his father had built themselves in 1921.'

One of Vanguard's ex-employees is supposedly sitting on documents showing how Vanguard avoided $1 billion in taxes.

David Danon, the ex-employee, doesn't seem to know that his ex-employer, Vanguard, is customer-owned and thus does not make any taxable profits by design. Vanguard charges its customers (me) the cost of operating the funds and no more. Profits are revenues minus costs, so there cannot be any profits under Vanguard's mode of operation.

'customer-owned and thus does not make any taxable profits by design'

Well, taxes are generally avoided or evaded by design, and as this article lays out, Vanguard's belief is likely to have its metaphorical day in court -

'Still, corporate tax lawyers and mutual fund industry observers contacted by The Inquirer say that Danon is basing his arguments on well-known provisions of federal tax law - and that his insider analysis, if upheld by courts and adopted by the IRS, could provoke changes, and perhaps reduce Vanguard's cost advantage in the marketplace.

By making funds and their investors its ultimate owners and squeezing profits out of operations, founder John C. Bogle made Vanguard "similar to a credit union or a traditional mutual insurance company," Vanguard says on its website and marketing materials.

But unlike mutual insurers and credit unions, which operate under well-established federal laws, no law gives Vanguard the right to operate on a tax-free basis, Danon argued in his lawsuit and in interviews with The Inquirer.

The assertions

Danon contends Vanguard Group has "illegally" reduced its federal and state tax liabilities in two ways:

By charging its funds below-market prices for investment advisory and other services - functions provided by Vanguard Group. The suit says that violates Section 482 of the U.S. tax code: The law requires payments for services between related companies to be sold at market prices, not discounted or inflated levels, so companies are not tempted to use such payments to shift or reduce reported income - and taxes.

By piling up a "contingency reserve" of cash payments from Vanguard mutual funds, without paying taxes on it. The reserve has topped $1.5 billion, Danon claims in his suit, citing confidential documents he gave federal and state agencies under whistle-blower statutes.'

Sounds pretty spurious. Vanguard's record speaks for itself and for the viability of a mutual structure in the business.

The rich getting richer is always good inequality, in the eyes of the rich.

"Even if you accept the diagnosis, then you do not accept the conclusion that very high — and very distorting — taxes and transfers are the best remedy."

Just to play devil's advocate, the "microfounded" rejoinder I'd give would be something that invokes the following:

The 2nd Fundamental Theorem of Welfare Economics states that "out of all possible Pareto-efficient outcomes, one can achieve any particular one by enacting a lump-sum wealth redistribution and then letting the market take over." To overcome the distortion issue, one could use what Milton Friedman deemed the "least bad tax," the non-distortionary Georgist land value tax.

Throw in some market imperfections and the Lipsey-Lancaster theory of the second-best, and one could probably come up with a scheme of transfers that's just as efficient and optimal (in theory) as the non-interventionist outcome with high inequality.

When did aggregate demand become synonymous with aggregate consumption? The stories about inequality reducing growth usually seem to depend on high MPCs among low earners reducing aggregate demand on a permanent basis, as if investment isn't part of aggregate demand. This is a good example of the value of writing down market clearing conditions and aggregate resource constraints.

"It is interesting how the diagnoses seem to follow the prescription."

I'm pretty sure that's the exact same insult that Krugman and the liberals use on the conservatives and their tax-cuts-solve-everything approach to politics.

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