Defending the indefensible

Greg Mankiw is professor and chairman of the prestigious economics department of Harvard University.  He is also author of the most widely used textbook on economics by university undergraduates.  So he could not be more ‘mainstream’.  Mankiw has a blog (http://gregmankiw.blogspot.co.uk/) and just published a new paper entitled,
Defending the 1% (http://scholar.harvard.edu/files/mankiw/files/defending_the_one_percent.pdf).

Mankiw is trying to be provocative and clever in this paper by arguing that there are perfectly good economic and even moral reasons for the top 1% of income earners in the US to have their huge share of total income.  In 2010, the top 1% had 17.4% of all income earned in the US, by any measure a very extreme level of income inequality.  As has been documented in many studies, that share of income going to the 1% has risen sharply from just (!) 7.7% in 1973.   Mankiw seeks to justify (defend) this more than doubling of the income of the 1% against the cries and protests of the Occupy movement.  He feigns to show sympathy with their ‘principles’ but his paper aims from beginning to end to refute all the arguments of ‘the left’ that this inequality is morally wrong or inefficient by using the principles of mainstream economics and a “healthy dose of political philosophy”.

His first defence is the one most used, namely that the reason the top 1% have had a rising share of income in the last 40 years has been the growing gap between the skills and education of workers.  ‘Skill-biased technical change’ has increased the demand for skilled labour and so incomes for the skilled have risen faster than the unskilled.  Mankiw quotes the usual study of his fellow Harvard economists, Claudia Goldin and Larry Katz  who have described this as a “race between education and technology.”   But there are plenty of other studies that argue something different has been going on.  In a working paper from the OECD, Kaja Bonesmo Frederiksen (Income inequality in the European Union, OECD Working paper 952, 16 April 2012), found that the reason that the top 10% did better was down to several factors: a decline in progressive taxation, rising capital gains from property and share ownership, so-called performance related pay, weaker trade unions and globalisation – indeed all the elements of the neo-liberal era – and not better technology skills (see my post, https://thenextrecession.wordpress.com/2012/12/12/apples-robots-and-robber-barons/).

The differences between the pay of the skilled and unskilled is not much different in the US compared to the UK or Europe.  And yet, as the OECD working paper shows, the ratio of the share of real disposable income growth going to top 10% over growth in income going to the bottom 10% averaged 2.6 times for the European Union, 9.1 times for the UK and a staggering 21.9 times for the US.  That means the top 10% of income earners in the US got 22 times more growth in income that the bottom 10% between the mid-1980s and 2008, while in France and Greece income growth for the bottom 10% was faster than for the top 10%!   So the most ‘neo-liberal’ capitalist economies saw the most unequal expansion in incomes.

Mankiw wants to dismiss the arguments of Joseph Stiglitz (The price of inequality, 2012) who argues that the top 1% have scooped the lion’s share of incomes because of ‘rent-seeking’, namely the ability to appropriate incomes produced through protectionism, cronyism and favourable regulations on tax and profits.  Mankiw says that ‘rent-seeking’ is no worse than 40 years ago, but this is an assertion without evidence in the same way that he criticises Stiglitz as making.

Mankiw insists that “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”.  Yet it is difficult to imagine that the chief executives of top companies have done so well because they are so much more skilled than 40 years ago rather than just because they have been able to siphon off more corporate profits through their control of company boards.  Mankiw denies that is the case because non-quoted private companies pay their chief executives even more than the boards of quoted companies pay theirs.  What that proves I don’t know, except that family companies can pay the head of their tribe whatever they like without any reference to wider shareholders.  The UK’s High Pay Commission found that chief executives  of large companies are often paid 70, 80 or over 100 times the salary of their average worker, when three decades ago the ratio usually stood at 13 to 1.

According to the UK’s Financial Services Authority, 1800 bankers in the City still earn more than £1m a year after the banking collapse. So income rewards are not related to performance, but to the power of capital.   The UK’s Institute of Fiscal Studies found that bankers’ bonuses had played a large part in creating this divide. “If you look at who is racing away, then half the top 1% of high earners work in financial services,” said the IFS researcher.  Mark Stewart, a professor of economics at Warwick University, has shown that “almost all the increase in inequality has come from financial services” in the past 12 years.  But Mankiw tells us that these investment bankers are “most talented” and therefore should be “highly compensated”.   He sort of admits that the earnings of the top investment bankers might just be ‘rent-seeking’.  So what society needs is to “devise a legal and regulatory framework to ensure we get the right kind and amount of financial activity”.  But “that’s a difficult task”.  Indeed it is.

Mankiw goes on: “a well-functioning economy needs the correct allocation of talent.  The last thing we need is for the next Steve Jobs to forgo Silicon Valley in order to join the high-frequency traders in Wall Street.  So we should not be concerned about the next Steve Jobs striking it rich but we want to make sure he strikes it rich in a socially productive way”.   If Steve Jobs is so ‘socially productive’, how does Mankiw suggest that we ensure such people are paid for their value contribution rather than all the income going to ‘rent seekers’ in unproductive jobs like footballers or commodity traders?  He has no answer in this paper. But anyway, who is to say that the great ‘innovators of  technology’ must be rewarded more than those who do just as important jobs like nursing, refuse collecting, sewage etc.  And indeed, many of the great inventions, discoveries and technological advances have been the product of teamwork and cooperation and not down to some hugely talented individual.

Mankiw also seeks to defend the 1% by arguing that their skills and cleverness are inherited: “smart parents are more likely to have smart children”.   So the reason some have more income than others is that they inherit their cleverness from their parents and there is nothing we can do about it.  It is a genetic inequality.  What Mankiw mistakes here is genetic differences with inheritance.  Genes may be passed on, but there is no reason why incomes or wealth should be passed on from parent to child.  The top 1% of income earners can perpetuate their income status for their children, but not because of their genes but because of their influence.  Take the current scandal that internships in lucrative companies can be arranged by rich parents working in them or knowing the contacts, while equally clever poorer kids don’t get a look in. 

Okay, Mankiw says, let us assume that there are serious inequalities of income that are ‘unfair’.  What can be done about it?  Apparently little.  Mankiw correctly points out that the US  income tax system is already progressive.  In other words, the more income you ‘earn’, the more you pay as a percentage in income tax.  The poorest fifth pay just 1% of their income in federal taxes, the middle fifth pay 11%  and top 20% pay 23%, while the top 1% pay 29% of their income in tax.  So federal taxes are progressive.  So what’s the problem, says Mankiw.

But federal taxes are not the only taxes that people pay (see my post, https://thenextrecession.wordpress.com/2012/09/19/romney-and-the-47/).  People also pay sales taxes, VAT, insurance taxes, capital gains tax and payroll taxes.  And these are not progressive at all.   Then there are the subsidies, allowances and exemptions from tax usually paid to the better off.  There is every reason to conclude that the whole taxation system could be way more progressive and so bring about greater equality of incomes.

But Mankiw appears to reject the case for government applying any redistributive  policies at all.  After all, he says, if you are born with two kidneys and somebody else has two failing ones, government should not be able to enforce the removal of one of your kidneys to give it to the other person.  Mankiw equates the forcible removal of a person’s kidneys with the democratic decision of a government to make top earners pay more to help lower earners and to spend on public goods!

Mankiw prefers what he calls a “just deserts” perspective – namely that a person should get an income congruent with his contribution to society.  On this perspective, there should not be higher taxation of those earning more because they are only receiving their ‘just deserts’, an income that matches their ‘marginal productivity’.  Mankiw thus presents us with the neoclassical concept of marginal productivity – a concept hugely discredited as bearing no resemblance to the reality of capitalism (see Fred Moseley’s critique of Mankiw and marginal productivity,http://www.paecon.net/PAEReview/issue61/Moseley61.pdf).

Mankiw discusses only the inequality of income in the US.  But global inequality is even greater (see my post, https://thenextrecession.wordpress.com/2010/01/10/20/) and clearly not the result of just technology and skill differences, but instead the product of trade and capital flows dominated and controlled by rich capitalist economies over weaker ones.

And Mankiw only talks of inequality of income.  But under capitalism, private (not common) ownership of financial assets, real estate and the means of global production is key.  So inequality in these ‘social’ assets is much more important and even greater than with incomes (see https://thenextrecession.wordpress.com/2012/02/28/free-markets-and-global-wealth).  The power of capital dominates and exploits labour and thus enables the 1%  to reap the benefits of the value created by the 99%.  Mankiw has nothing to say about this.

Marx never advocated ‘equality’, if we mean by that completely equal incomes or personal wealth for each person or household unit in a society.  But neither was the Marxist perspective one of ‘just deserts’.  Instead, it was “from each according to his/her abilities; to each according to his/her needs”.  People (Steve Jobs) may have different or ‘unequal’ abilities, but a commonwealth would provide for all according to their needs.

9 Responses to “Defending the indefensible”

  1. Dion Giles Says:

    Comments like that of Mankiw, and nearly all comment to be found anywhere opposing them, overlooks the fundamental truth about the creation of wealth. The SOLE source of wealth consists of the bounty of nature together with human-created goods and services brought to the point of use. The creators of wealth – the makers – are those who PERSONALLY create goods and services, brought to the point of use. Investors create no wealth. Zero. Zilch. At most they ALLOCATE wealth produced by makers. Capital is allocated wealth. Makers are essential to human requirements. Investors, having acquired wealth, are sought-after as allocators. But make no mistake, they are takers, not producers. They are surplus to human requirements. Indeed contrary.

    Every cent of profit from investment is extracted from the wealth created by makers, and the disparity between the wealth of the 1% and that of the 99%.is not merely a measure of the success of the one-percenters but of what they have TAKEN FROM the makers. That is the physical reality behind the economic dislocations and injustices which Martxists explore. It underlies the capitalist system that we have got so used to that we find ourselves seeing a process of theft as if it was a law of nature with its own rules for producing winners and losers.

    By the same token, so-called “austerity” is transfer of the accumulated wealth created by the makers across to the takers, impoverishing the very people entitled to be gaining a living from it.

  2. Neil Says:

    It depresses me no end to hear that Mankiw is no fringe libertarian economist but professor and chairman of the economics dept at Harvard and author of the most widely used undergraduate economics textbook – particularly as it is now 5 years since the crash and with the crisis continuing to evolve.

    The picture it presents of the mainstream economics profession and the commanding heights of academia is morally disgusting and intellectually barren. Suffice it to say that I place mainstream orthodox economists such as Mankiw on the same level as pornographers as potential corrupters of the young. The epitome of ‘truth’ as power – no intellectual argument, evidence or criticism can have any effect on these people. What can be done about it I wonder.

  3. mark kane Says:

    Hi, just a suggestion, but it would be nice if you dis an analysis on the uprising in Brazil at the moment

  4. BrianJay Says:

    Yes but Michael. WHO determines my ability and needs. That’s why the ‘old man’s movement keeps splitting.

  5. Charles Says:

    Does Harvard economics chair Mankiw have an appendix to his paper that explains why his departmental colleagues Rogoff and Reinhart enjoy high-end professorships as a reward for their paper on debt and growth? That was the “research” in which, according to your moral judgment, they falsified the data or they showed they could not do elementary spreadsheet work.

  6. Majid Says:

    The role of government is the central issue of Mankiw and your critical argument, once we realize a big distributional gap. Is it unfair? Is there any ‘scale’ for addressing the level of unfairness? There does not seem to be any answer. Mankiw suggests the gap is alright and in a well-functioning economy it should be attributed to some value generation ability of the rich. He does not have a proof for this, because it is almost impossible to provide one. The rent-seeking counter argument of Stiglitz is a possible explanation which does not seem to have obvious (studied) justification either.

    Here is the theory: The market mechanism and the price system should manage to signal the needs of people to the producers and innovators, who in turn need the resources to fulfill this task. The main instrument to hire resources and manage them is the medium of exchange or money. Wealthy investors who can finance projects provide the opportunity for entrepreneurs / corporations to function and create wealth and they take the corresponding risk. As long as there is competition, rents should be small. Otherwise, margins of profits are large and the wealthy gets wealthier. Here is when progressive redistribution of wealth should make sense.

    Any comments?

    • Dion Giles Says:

      Investors take risks but they create no value. The capital they invest represents goods and services translated into wealth acquired by the investor. Investing is not contributing, it is merely ALLOCATING wealth to the pro0ductiuve process.

      • Majid Says:

        So you mean taking risk does not create value. What is ‘risk’? Compensation for probability of losing at some states with higher payoff in the favorable states. Think of insurance. As long as the bad event does not take place, ‘no value’ is created. But in case of loss, it is the insurance company who covers the costs and saves the insured. At this level of abstraction, without going into the details of what occurs in the real world (bargaining powers, agency problems, collective decisions among large corporations), one can think taking risk is contributing to creation of value.

        Think of the investor as a worker who earns money by working and producing and invests the proceeds in some company. The investor forgoes enjoying his/her money and takes the risk by providing funds for a business to run.

  7. Dion Giles Says:

    Curses. I got to the very last word of a reply to Majid, with non-capitalist alternatives to the concept of the world depending on wealthy investors allocating funds in their own interests to create a world of Greeces and Spains and Global Financial Heists − and the lot disappeared from my screen without trace!

    Providing insurance from wealth acquired through one’s own wealth-creating labour is providing a service to a productive process and thus is creation of wealth. However, if a multiplier effect kicks in – investment creating new wealth for the investor to invest, his/her creation and acquisition of wealth morphs into theft. Risk is not wealth. Gamblers create nothing. Al Capone created nothing by risking Alcatraz.

    So where do the funds to run society’s functions, including the heavy lifting in investment for production and innovation, come from, given that personal investment of genuinely earned money is peanuts in the composition of the investment market? Taxation.

    And where do the taxes come from? Wages, which have increased severalfold once the burden of the acquisitions community is shucked off. Taxes would be steep once the producers inherited the load of investment. The risk (investments going pear shaped) is shared among the whole people.

    How is the allocation of invested wealth decided? By an administration working openly under strictly democratic control, with administrators’ wages related to success of his/her allocations. The shape of strictly democratic control, and the transformation of representative government into democracy (rule of the people by the people for the people, not rule of the people by the pollies for whoever buys them) is a bigger subject but it’s doable and I could blather on for pages about that.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s


%d bloggers like this: