Review: The Price of Inequality

price of inequality

In The Price of Inequality (2012), Nobel Prize winning economist Joseph Stiglitz takes aim at economic inequality in contemporary American society. He spends the bulk of his 400 pages attempting to spell out both the causes and consequences of inequality. At the center of Stiglitz’s account is the concept of the one percent and the ninety-nine percent. First popularized by a Vanity Fair article penned by the author in May 2011, the one and the ninety-nine refers to two classes of people in American society—separated by income and wealth—whose interests are adverse and whose fates are inextricably intertwined. The former controls much of the economy and has reaped a disproportionate share of American prosperity while the latter suffers insecurity and “relative deprivation” (Stiglitz 2012, 105). The cause of this unfortunate state of affairs is rent seeking behavior on the part of a short-sighted elite and facilitated by a captured, feckless state. The consequence of this trend is “a democracy that has been put into peril” (Id. at vi) as the promise of “one person one vote” devolves into “one dollar one vote” (Id. at xvi). This dynamic, says Stiglitz, is a recipe for increasing inequality and social unrest, which will harm even the one percent over the long-term. In this post, I discuss Stiglitz’s treatment of rent seeking before addressing two minor points of contention.

ninety-nine percent

Note: Inequality as a Normative Consideration

I should say before I begin that I purposely leave aside the issue which Stiglitz takes for granted of whether income or wealth inequality, as such, is a problem for which there is a moral obligation to solve. At the very least, inequality exists on a continuum and societies are bound up by a common set of expectations. At some extreme, disappointment of these expectations arising from a large material differential and the belief that there is a distinct set of governing rules for different segments of the population engenders resentment and threatens a social cohesion upon which the formal governing mechanisms depend. To put it crudely, there will never be enough police to back up a system in which a substantial segment of the population has not “bought in” to a common set of norms. Developmental economist Paul J. Zak has demonstrated that economic policies aimed at cultivating economic growth must be developed with an appreciation of  how certain growth paths might produce differential gains in a given society which increases social instability. If substantial numbers of disaffected persons choose to seek their welfare outside official channels, the cost of instability can off-set any gains from an otherwise sound growth strategy. In short, what people believe about the relative rewards of their socio-economic system matters, and economic policies do not exist in social vacuum. Now, to Stiglitz.

I. Rent Seeking: A Social Bad

Rent seeking is a term that looms large in Stiglitz’s analysis of America’s growing inequality. Within economics, the term rent implies the accrual of income absent a corresponding generation of value. The term derives from law, where rents normally follow the legal right to exclude others from an object of value; for example, a landlord may charge a tenant a given sum (rent) for access to the landlord’s land. Since at least the 1970’s, the term rent seeking has been employed to denote the use of political mechanisms to achieve economic gains. Rent seeking is considered a pathology of political life because competition for political favors shifts the relevant margins of performance away from socially beneficial activities (e.g., production of superior products at lower cost than a competitor) to those which garner advantage without social benefit (e.g., lobbying to legally exclude a competitor). Rents are also internally inefficient for the rent seekers. Typically, when A, B, and C, bid on a legal privilege, the contribution of all but the winner is sunk or unrecoverable. Hence, while competition over the rules may often prove more attractive than competition under the rules, rent seeking is not a socially optimal strategy and tends to undermine social trust and cohesion.

It is no wonder then that Stiglitz spends the bulk of his book highlighting the deleterious effects of rent seeking on American economic and social life. In one passage, worth quoting at some length, Stiglitz describes the U.S. ethanol subsidy thusly:

A plan to reduce our dependence on foreign oil by replacing it with the energy of the sun embedded in one of America’s great products, its corn, seemed irresistible. But converting plant energy…is easier to do with some plants than others. So successful has Brazil’s research on sugar-based ethanol been that in order for America to compete, for years it had to tax Brazilian sugar-based ethanol 54 cents a gallon. Forty years after the introduction of the subsidy, it was still in place to support an infant technology that seemingly would not grow up. When oil prices fell after the 2008 recession, many ethanol plants went bankrupt, even with massive subsidies. It wasn’t until the end of 2011 that the subsidy and tariff were allowed to expire (Id. at 50-51).

Why did it take so long to end the sweetheart deal with American ethanol producers? Stiglitz highlights one important beneficiary: megafirm Archer Daniels Midland. “Like so many other executives,” he says, “those at ADM seemed to be better at managing politics than at innovation” (Id. at 51).

Of course, there are many different reasons offered for subsidies and protective barriers of this kind. Cato Institute agricultural economist Sallie James recently upbraided Senator Grassley (R, IA) for his insistence on farm subsidies. Among justifications such as national security, the senator added that “We have to start talking in terms of a sure supply of food to make sure that we have social peace in our country.” James responded rather colorfully:

Don’t buy what these folks are selling, America. Appeals to national defense are often the third-to-last refuge of the scoundrel (the last being patriotism and the second-to-last “for the children”) and in any case are a red herring when it comes to farm subsidies. No one is going to starve in this country if we get rid of farm subsidies. The Germans and Japanese subsidize their farmers for the same reason we do: because they’re a powerful political force. And as for claims that farm subsidies preserve “social peace”? What absolute rot. Favoring special interests at others’ expense fuels resentment and undermines social harmony.

Ms. James and Mr. Stiglitz are united in their belief that rent seeking is a social bad that must be stopped for the public good. Both economists agree that the rules of the game are being manipulated to achieve concentrated benefits for a few accompanied by large but diffuse cost to the many. Mr. Stiglitz however uses the language of market failure to describe such phenomena and eschews the accusation of government failure. Ms. James might argue the reverse.

In standard economic theory, market failure—a failure of the market to achieve an optimal equilibrium outcome predicted by an abstract model—is the main justification for government action in the economy. Some scholars have cautioned against reliance on models which abstract away from the ordinary features of life to establish normative benchmarks for economic performance. Others still have cautioned against focusing narrowly on the inevitable failure of markets to obtain a stylized outcome. They counsel focusing instead on a comparative institutional analysis to determine which set of political-economic arrangements is most likely to harness knowledge and incentives in ways most conducive to human flourishing. For those who take this latter perspective, the relevant question is not whether the market or the government failed, for neither of these institutional artifacts exists independently of the other. The relevant question is, “What is wrong with this relationship?” or “How might knowledge be better processed and incentives better aligned?”

Late Chicago economist George Stigler argued in his famous article “The Theory of Economic Regulation” (1971) that rent seeking is endemic to complex regulatory environments where the relationships between the government and the private entities they govern are convoluted and opaque to the general public. In fact, Stigler argues, “as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit” (Stigler 1971, 3). Just as political scientists have found in the study of interest group politics, the spoils of such processes tend to go to the sophisticated, the organized, and the vested.

Mr. Stiglitz sees the problem of rent seeking as evincing a weakened democracy and his answer involves creating “a more democratic democracy” (Stiglitz 2012, 135). However, as Mancur Olson made clear in The Logic of Collective Action (1965), this feature of regulatory politics is not a breakdown of democracy; it is an unfortunate outworking of pluralist democratic theory (See, e.g., Baumgartner & Leech’s survey of the interest group literature, Basic Interests (1998)). Firms that compete with other firms under a set of simple, stable rules have no recourse to competition over which rules should apply and must therefore compete along margins which enhance social welfare, i.e. cost and quality. However, each successive government intervention putatively aimed at correcting random market error compounds to generate the complex rule-environment which proves so ripe for the obscure manipulations of sophisticated incumbents. Regressive taxation schemes and ethanol subsidies do not arise or persist in a vacuum. They incubate in a dense web of micro-interventions each justified by expected social welfare enhancement. Buchanan and Wagner (1977), for example, observe with respect to tax policy that “complex and indirect payment structures create a fiscal illusion that will systematically produce higher levels of public outlay than those that would be observed under simple payment structures.” Thus, a commitment to address various and sundry micro-level market errors—which Stiglitz counsels throughout his work—contributes to a web of government-market relations that obscures distributional effects and insulates rent seekers from censure.

II. Two Minor Points

Rent seeking merits more discussion than a blog post permits, but I truncate the discussion still further to address two other points raised by the author before concluding. First, Mr. Stiglitz laments that one of the consequences of increasing inequality is that “80 percent of the young are so alienated that they don’t even bother to vote” (Stiglitz 2012, 288). However, this claim is contradicted by a wealth of research in the voter turnout literature. Alienation has been often theorized but seldom substantiated as a cause of lower than expected turnout, and non-voting tends to be higher among the “more politically ignorant” (Bennett & Resnick 1990, 787). Thus, as hinted in the prior discussion, increasing complexity in the political economy may lead some individuals to self-select out of the decision-making process. This lack of engagement need not be interpreted as alienation. It might demonstrate complacency or a high level of confidence that the system will perform reasonably well without one additional unit of participation. Indeed, a lot of engagement might portend trouble; it might mean that many people see the system as diverging so much from expectations that they must direct their scarce attention to resolving it themselves.

Moreover, scholars in the field have found that the reputed decline in voter turnout over the last two generations is a myth attributable to measurement error (McDonald & Popkin 2001). Others have reversed the presumption to ask why, given information costs and the trivial impact of an individual vote, so many citizens do vote (Campbell, et al 1960). If voting is intrinsically valuable (e.g., the “expressive” vote), it is subject to subjective valuation. If voting is instrumentally valuable, some citizens may find that the expected cost of a well-informed vote exceeds its benefits. Given the opaque nature of the political economy for even educated, informed persons, it is unlikely that an increase in voter turnout—which Mr. Stiglitz may consider synonymous with an increase in democracy—would substantially alter the political economic landscape. As the work of Kenneth Arrow long ago demonstrated, democracy as such does not handle complexity well.

those were the days

The second minor point I wish to address before concluding is found in Mr. Stiglitz’s concluding remarks. There, he states his belief that “it is still not too late for this country to change course, and to recover the fundamental principles of fairness and opportunity on which it was founded” (Stiglitz 2012, 288, emphasis mine). This blithely nostalgic remark turns American history on its head. America was founded on a compromise in which black Americans were mere property to be bought, sold, beaten, raped and murdered with impunity. This class of persons was not constitutionally free until 1865 and remained blatantly relegated to second-class status for at least another hundred years. Women were not guaranteed the right to vote until 1920. The Irish and the Chinese were systematically mistreated throughout the nineteenth century. Americans of Japanese descent were interned during the 1940’s with the support of the Supreme Court. No conscientious American familiar with this history wants to recover those principles of fairness. Considerable progress toward fairness has been made since that “golden” age of the founding. Mr. Stiglitz must be careful not to lose perspective on issues of fairness in which the normative import is clear and unambiguous even as he seeks to extend the public discourse along other margins of human flourishing.

A.K.

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