Angus Deaton: US inequality and the Pareto Criterion: Saturday Reading

Angus Deaton: US inequality and the Pareto Criterion:

There is much to be said for equality of opportunity, and for not penalizing people for the success that comes from their own hard work. Yet, compared with other rich countries, and in spite of the popular belief in the American dream that anyone can succeed, the United States is in fact not particularly good at actually delivering equal opportunities.

One way of measuring equality of opportunity is to look at the correlation between earnings of fathers and sons. In a completely mobile society, with perfect equality of opportunity, your earnings should be unrelated to what your father earned; by contrast, in a hereditary caste society, in which jobs are handed from one generation to the next, the correlation would be 1.

In the United States, the correlation is 0.5, which is the highest of the OECD countries and is exceeded only by those of China and a handful of countries where there appears to be the least equality of opportunity.

Even if we believe that equality of opportunity is what we want, and don't care about inequality of outcomes, the two tend to go together, which suggests that inequality itself is a barrier to equal opportunity.

What about envy of the rich? Economists have a strong attachment to something called the Pareto principle, which we first met in the Introduction: If some people are made better off and no one is made worse off, the world is a better place. Envy should not be counted. The maxim is often cited as a reason to focus on poverty and not to worry about what is happening at the top.

In the words of Martin Feldstein, a Harvard economist, "income inequality is not a problem in need of remedy." There is a lot to be said for the Pareto principle, but, as we shall see, it does not imply that rising income inequality is not a problem....

The political scientists Jacob Hacker and Paul Pierson argue that political lobbying has played a key role in the increase in top incomes. They note that the number of firms represented by registered lobbyists in Washington increased from 175 in 1971 to 2,500 in 1982, in large part a reaction to the wave of government regulation of business associated with the Great Society.

Changes in what appear to be arcane or obscure rules on how markets operate, on what firms can or cannot do, or on accounting rules can mean immense sums to particular interests.

This was true of the repeal of Glass-Steagall, and there are many other examples over the period leading up to and after the Great Recession. A spectacular example was the semipublic mortgage finance company Fannie Mae, which was run by well-connected political who enriched themselves and their senior executives through ultimately catastrophic risk taking while keeping regulators at bay by means of well-funded campaigns of political influence.

If these accounts are even partially correct, there is a danger that the rapid growth of top incomes can become self-reinforcing through the political access that money can bring. Rules are set not in the public interest but in the interest of the rich, who use those rules to become yet richer and more influential.

The countries in the OECD that have seen the largest increases in shares of income at the very top are the countries that have seen the largest cuts in taxes on top income. Studies of congressional voting by the political scientists Larry Bartels and Martin Gilens have documented how votes in Congress from both sides of the aisle are sensitive to the wishes of rich constituents and not at all to the wishes of poor constituents. ...

The process of cumulative causation, through money and politics, is far from fully documented, although both political scientists and economists have begun to show serious interest. What we are currently lacking are good notions of the size of the various effects -- what fraction of the increase in top compensation comes from lobbying or other political activities, what fraction can be attributed to the high productivity of top earners, and just how much of political activity comes from those interests as opposed to the many others, such as unions, that are also well represented in Washington.

We also don't understand why these influences should have become so much more powerful over time, if indeed they have. The answers to those questions are central for deciding just how much we should be worried about the rise in top incomes and why worrying about the rich getting richer is a good deal more than envy.

If democracy becomes plutocracy, those who are not rich are effectively disenfranchised. Justice Louis Brandeis famously argued that the United States could have either democracy or wealth concentrated in the hands of a few, but not both. The political equality that is required by democracy is always under threat from economic inequality, and the more extreme the economic inequality, the greater the threat to democracy.

If democracy is compromised, there is a direct loss of wellbeing because people have good reason to value their ability to participate in political life, and the loss of that ability is instrumental in threatening other harm.

The very wealthy have little need for state-provided education or health care; they have every reason to support cuts in Medicare and to fight any increase in taxes. They have even less reason to support health insurance for everyone, or to worry about the low quality of public schools that plagues much of the country. They will oppose any regulation of banks that restricts profits, even if it helps those who cannot cover their mortgages or protects the public against predatory lending, deceptive advertising, or even a repetition of the financial crash.

To worry about these consequences of extreme inequality has nothing to do with being envious of the rich and everything to do with the fear that rapidly growing top incomes are a threat to the wellbeing of everyone else.

There is nothing wrong with the Pareto principle, and we should not be concerned over others' good fortune if it brings no harm to us. The mistake is to apply the principle to only one dimension of wellbeing -- money -- and to ignore other dimensions, such as the ability to participate in a democratic society, to be well educated, to be healthy, and not to be the victim of others' search for enrichment.