Friday, September 30, 2011

A Critique of the Arguments for Inequality

The always-thoughtful John E. Roemer gave a talk on "The Ideological and Political Roots of American Inequality" at a conference last February. The talk is available as a working paper here; a revised version of the talk appears as an article with the same name in the September-October issue of Challenge magazine, which is available on-line if your library has a subscription. I quote here from the working paper version.

A First Argument for Inequality: Individuals Deserve to Benefit from Their Endowments

The first argument that Roemer considers for inequality is "an ethical one, that individuals deserve to benefit from what nature and nurture endows them with ... The first argument is presented in its most compelling form by thephilosopher Robert Nozick, who in his 1974 book, Anarchy, State and Utopia, advanced the idea that a person has a right to own himself and his powers, and to benefit by virtue of any good luck that may befall him, such as the luck of being born into a rich family, or in a rich nation. ... Nozick is the first the admit that actual capitalist economies are not characterized by historical sequences of legitimate, voluntary exchanges: there is much coercion, corruption, and theft in the history of all societies. But Nozick’s point is that one can imagine a capitalism with a clean history, in which vastly unequal endowments of wealth are built up entirely from exchanges between highly talented, well educated people and simple, unskilled ones, and this unequal result is ethically acceptable if one accepts the premise that one has a right to benefit by virtue of one’s endowments – biological, familial, and social – or so he claims."

Responses from Rawls and Dworkin to this first argument

"The philosophical response to Robert Nozick’s libertarianism came primarily from two political philosophers, John Rawls and Ronald Dworkin. ... Rawls attempted to construct an argument that, if rational, self-interested beings were shielded from the knowledge of the luck they would sustain in the birth lottery, which assigns genes and families, they would opt for a highly equal distribution of wealth – indeed, for that distribution which maximizes the wealth that the poorest class of people would have. . ... The error in Rawls’s argument that those in an original position, behind a veil of ignorance, would choose a highly equal distribution of income, came from his assumption that the decision makers postulated to occupy this position were completely self-interested. Self-interested individuals may be willing to take some risk in the birth lottery – they may be willing to accept some possibility of an unlucky draw in return for the possibility of a lucky draw. ... This does not mean that a strongly equalizing tax system is ethically wrong: but to justify it with the kind of argument Rawls wished to
construct requires that individuals care at least to some degree about others. Rawls’s attempt to derive equality of results from premises of rationality and self-interest fails. ... There was another aspect of Rawls’s theory that was unattractive to some: there was no evident place in it for the role of personal responsibility and accountable choice. ... Ronald Dworkin, in 1981, published a pair of articles which addressed this problem in a radical, new way. He advocated what he dubbed ‘resource equality’ ... In Dworkin’s view, people should be held responsible for their preferences, but not for their resources – where resources include many of the goods that Rawls called morally arbitrary, such as genetic endowments and the social and familial circumstances of one’s childhood. ... Thus, a degree of equality was recommended that was less than Rawlsian, but far more than exists in most advanced democracies today."

A Second Argument for Inequality: Incentives

The second argument that Roemer considers about inequality is "the instrumental one: that only by allowing highly talented persons to keep a large fraction of the wealth that they help in creating will that creativity flourish, which redounds to the benefit of all, through what is informally called the trickle-down process. In a word, material incentives are necessary to engender the creativity in that small fraction of humanity who have the potential for it, and state interventions, primarily through income taxation, which reduce those material rewards, will kill the goose that lays the golden eggs."

A Response: Contrasting The Market Role in Coordination and Incentives

"Economists have long realized that markets perform two functions: they coordinate economic activity, and they provide incentives for the development of skills and innovations. It is not easy to give a definition which distinguishes precisely between these two functions, but there is no question that a conceptual distinction exists. ...  In the last thirty or forty years, the economic theorist’s view of the market has changed, from being an institution which performs primarily a coordination function to one that is primarily harnessing incentives. Indeed, the old definition of micro-economics was the study of how to allocate scarce resources to competing needs. This is entirely a coordination view. ...

It may surprise you to hear that the phrase ‘principal-agent problem’ was only introduced into economics in 1973, in an article by Steven Ross. In the principal-agent problem, coordination is not the primary issue – rather, a principal must design a contract to extract optimal performance from an agent whose behavior he cannot perfectly observe. This is par excellence an incentive problem. ...

"The punch line I am proposing is this: to the extent that the market is primarily a device for coordination, taxation can redistribute income without massive efficiency costs. But if the market is primarily a device for harnessing incentives, the efficiency costs of redistribution may be high. ..Although economic theory has shifted on this question during the last generation, it is far from obvious that the shift is empirically justified – by which I mean, we do not know that the market’s role in incentive provision is as important as current economic theory contends. ..."

"I have argued that these high incomes are inefficient, because of risk-taking externalities that they induce, that they are unnecessary for incentive provision, and that they create a class with disproportionate political power. Finally, there is the very important negative externality of the creation of a social ethos which worships wealth. ... In sum, the positive social value of the institution of extremely high salaries that the leaders of the corporate world, and in particular, of the financial sector, receive, is a big lie. It may well be a competitive outcome, but it is a market failure which could be corrected by regulation or legislation."

A Third Argument for Inequality: Policy Futility

"A third argument for inequality, which is currently most prevalent in the United States, is one of futility: even if the degree of inequality that comes with laissez-faire is not socially necessary in the sense that the incentive argument claims, attempts by the state to reduce it will come to naught, because the government is grossly incompetent, inefficient, or corrupt. ... This is, I think, a particularly American view, so it is probably not appropriate to spend much time on it here."