Inequality? So 2010s!
After a decade of clamoring for greater government intervention, the tide might be turning.
Is inequality going out of fashion?
Last week’s Economist cover feature proclaimed: “The conventional view that inequality is rising inexorably is wrong.”
Blue collar revenge
There are two parts to the story. The first is that economic, demographic and technological trends may be shifting in favor of blue-collar workers: aging populations shrink the pool of employees just as governments keep goosing demand, and the latest advances in Artificial Intelligence bring stronger competition for white collar jobs.
There is a lot of uncertainty on how technological innovation will impact the job distribution; but whether technology is playing a major role or not, the data do show that blue collar workers are finally gaining ground: as The Economist notes, real weekly earnings at the bottom of the US income distribution have outpaced those at the top since 2016, and by some estimates have reversed about 40% of the previous rise in pre-tax income inequality.
This by the way implies a shrinking of the premium for higher education that might in part reflect the steady deterioration of the education system (see my previous post.)
Remember Marx…I mean, Piketty?
The second part is more interesting. That’s where the reference to “inequality rising inexorably” comes in. Remember Thomas Piketty? The MIT-trained French economist became a global celebrity with his 2014 book Capital In The Twenty-First Century, its title a friendly nod to Karl Marx, where he asserted that rising inequality is an unavoidable feature of the capitalist economy, as unbendable as the laws of physics. Together with co-authors (and, not coincidentally, compatriots) Emmanuel Saez and Gabriel Zucman, Piketty has since been relentlessly condemning the social evils of the capitalist system and proclaiming the need for overwhelming corrective government intervention.
If the three musketeers of inequality are right, the current trend in favor of blue collar workers is at best a passing aberration that will do nothing to stop inequality and economic injustice.
The Economist highlights a recent academic paper that flatly contradicts the Piketty results. Using a different methodology, the paper shows that far from increasing inexorably, income inequality in the US has hardly risen at all since the 1960s.
Fickle fashion
What I find truly interesting here, however, is that we are not witnessing a breakthrough in economic research: rather, we are witnessing a shift in ideological fashions:
That Piketty’s thesis suffered from major conceptual and methodological problems was obvious from day one. First and foremost, his conclusion relies crucially on the assumption that the rate of return on capital, “r”, is always higher than the rate of return on economic activity, or the rate of growth of the economy, “g”. If that’s the case, than having capital will always make you richer than working, and inequality will rise inexorably, with the rich getting richer and the poor working for a pittance. Piketty posited r>g as essentially a law of nature. The amusing thing is that even a chart in his own book showed extended periods when g is greater than r, so that r>g seems more like a counterfactual article of faith than a law of economics.
The economist Matthew Rognlie quickly pointed out that Piketty’s results were heavily biased by the price appreciation of housing and land. Larry Summers criticized Piketty for underestimating the diminishing marginal return to capital (again the “r” vs “g” issue.) You might also enjoy watching Summers’ brutal take-down of Saez and Zucman’s wealth tax proposal in this video (starting at about 20:00). And you can find here a more exhaustive list of early criticisms of Piketty’s work.
Nonetheless, for the longest time all these criticisms have been ignored by the media and largely dismissed in the public debate, while the thesis that inequality has increased sharply and will inexorably increase further has been accepted as gospel. Indeed, The Economist itself gave a warm and approving reception to Capital, calling it “an authoritative guide” to the issue of inequality in capitalist economies, which “suggests that some 20th-century conventional wisdom was badly wrong.”
we are not witnessing a breakthrough in economic research: rather, we are witnessing a shift in ideological fashions
Taxes? What taxes?
I’ve always found it stunning, for example, that the debate on inequality has been consistently based on pre-tax and pre-transfer incomes. That’s right: most of the media headlines you have seen over the past decade lamenting the rise of inequality were based on data that completely ignored the impact of taxes and social transfers. Consider how crazy that is: you denounce income inequality and call for government intervention to mitigate it through taxes and social transfers; the government obliges, but you then refuse to measure the impact of those same taxes and transfers so that you inevitably come to the conclusion that no improvement has been achieved, call for even greater government intervention, and so on and so forth… Already a few years ago Congressional Budget Office data showed that accounting for the impact of taxes and transfers, income inequality had not increased at all since the end of the 1970s. But why let the facts stand in the way of an effective populist argument?
So it’s a bit odd to make it sound like the arguments of Piketty and co. are being debunked only now. They were debunked ten years ago. Even more interesting, the same Economist that hailed Piketty’s arguments ten years ago now has swung to the opposite extreme; the inside article on the academic research is quite nuanced, pointing out that when measuring inequality, the data are messy, methodological issues are thorny, and the debate remains contentious — the latest “no-rise-in-inequality” research is itself subject to criticism (here is a technical rebuttal by Piketty Saez and Zucman). The cover editorial however takes a much more decisive stance: now it’s the Piketty view that is “wrong” rather than previous conventional wisdom.
Wind and tide
Maybe it’s a sign that the wind is shifting. The years since the 2008 global financial crisis have been dominated by increasingly harsh criticism of capitalism, handwringing about rising inequality, and loud calls for higher taxes and greater government spending, aided and abetted by irresponsible economic arguments like Secular Stagnation and Modern Monetary Theory, as well as creative apologies of the driving role of government in innovation. Now that all we have to show for it is a spectacular increase in the cost of living and massive public debts weighing heavily on slow-growing economies, maybe the tide is beginning to turn. Maybe. Don’t hold your breath.
P.S. the Fed
That was fun. With markets already anticipating easier policy, Fed Chairman Powell executed a remarkably nimble pivot that supercharged the market rally. Barely ten days after saying the Fed was not discussing rate cuts, he came on stage and said they had just discussed rate cuts. He all but declared victory on inflation, even though core inflation ex-food, energy and housing — which the Fed itself noted as most representative of underlying price pressures — is running above 5%, as are wages (according to the Atlanta Fed tracker). Why did Powell feel the need to give markets an extra boost? Maybe the Fed genuinely feels confident that the inflation battle has already been won. Maybe they think that if inflation stays at 3-4% next year it’s not a big deal as long as growth holds up and markets are happy. Only a cynic would think this might have anything to do with 2024 being an election year. You’re not a cynic, are you? Me neither. To make matters more interesting and amusing, New York Fed President Williams then said they had not discussed rate cuts.
P.P.S. Characters in a simulation or pawns in a game?
I take the Powell-Williams disagreement as further proof that, as Nick Bostrom hypothesized, we live in a simulation. In fact, more than one, because clearly, Powell and Williams live in two different simulations.
On the other hand…the chart below shows how AI-driven online matching has fast become by far the most common way humans pair up. So maybe we are not characters in a simulation — we are pawns in a game played by the AI. What might the AI’s goal be? Luckily you are not a cynic, and neither am I.