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Commentary On N. Gregory Mankiw's "Defending the One Percent 1"
While Professor Mankiw makes many good points in this paper, there are better arguments for taxing the wealthy than ones he attacks, and there are broader issues at work in those he does consider. For example, his own "just deserts" theory is grounds for taxing the wealthy for redistribution purposes if their wealth comes at the expense of other people's labor that is unfairly insufficiently rewarded.
His paper begins by asking us to
"[i]magine a society with perfect economic equality. Perhaps out of sheer coincidence, the supply and demand for different types of labor happen to produce an equilibrium in which everyone earns exactly the same income....The main question Mankiw then raises in this thought experiment (which he takes to "capture... in an extreme and stylized way, what has happened to US society over the past several decades") is whether "government policy makers should deplore the resulting inequality and use their powers to tax and transfer to spread the gains more equally." He argues they should not.
He points out that
"addressing the issue of rising inequality necessarily involves not just economics but also a healthy dose of political philosophy.... Given the topic, that is perhaps inevitable. But it is useful to keep in mind when we are writing as economist and when we are venturing beyond the boundaries of our professional expertise."It is my own view that "political philosophy" should be (but usually isn't) subservient to ethics (also called moral philosophy) and that economics, at least in the sense of economic policy making, and even in regard to many economic choices people make, needs to take into account ethics as well as the science of economic practices. So I would say that where Mankiw says this issue involves a healthy dose of political philosophy, I would say it involves a healthy dose of ethics or ethical understanding, which is basically what he is writing about in this article. I take political philosophy to be about the philosophy, and primarily moral philosophy, issues of governing. It is essentially about the ethics and problems of governing (large) groups, perhaps particularly in regard to devising workable large-scale general rules (laws, regulations, policies, etc.), as opposed to determining what is right to do in particular circumstances toward specific individuals, insofar as there might be a difference.
Now the instinctive and implied conclusion of Mankiw's proposed thought experiment is that, because it embodies the Pareto criteria that no one has been made worse off, and at least one person, in this case the entrepreneur, has been made better off, there is nothing wrong with this kind of inequality. I will challenge that in a moment, but Mankiw considers the challenge that "inequality is inefficient in the sense of shrinking the size of the economic pie.... If the top 1 percent is earning an extra $1 in some way that reduces the incomes of the middle class and the poor by $2." His rebuttal to that is that the claim is based on, or could result from successful "rent-seeking" -- government policies favorable to some at the expense of others -- which is deplored by economists, including him. But he goes on to argue that the rise in income of the top one percent does not stem from successful rent-seeking and stems instead from higher education and greater talent, assisted by technological advances that allow (quoting Erik Brynjolfsson and Andrew McAfee book Race Against the Machine) "entrepreneurs, CEOs, entertainment stars, and financial executives [to] leverage their talents across global markets and capture reward that would have been unimaginable in earlier times (p.44)." He holds that education can allow others to advance too and that when it doesn't, it is the result, not of successful rent-seeking, but of supply and demand, where education does not keep up with the demand for skilled labor, and those who have the skills needed will earn much more than those who do not. Now whether the lower and middle classes have reasonable access to such educations is somewhat suspect, and Mankiw addresses it later. But what he does not address is whether it is fair or not for the benefits of technology, which favor certain kinds of talent, to create such wide income gaps, even if the people at the lower end are/were not disadvantaged. I will address that later in this paper.
Moreover it is not clear there can be a government or economic position devoid of, or neutral in regard to, rent-seeking or any kind of "favoritism" when it comes to a reasonable distribution of income or profits generated. For example, whether collective bargaining is permitted or not favors either labor or management. If management can bargain with individuals and not with unions, they can exploit those with greater needs to work for lower wages and benefits, giving management and ownership (and perhaps customers) more benefit or profit at the expense of workers; if collective bargaining is permitted, workers gain an advantage at the expense of management and ownership (and perhaps customers). Similarly with regulation and deregulation, much of which has to do with responsibility for the moral and economic costs of preventing, minimizing, or remedying harmful 'externalities,' and with patents and copyright. Without patents, those who do research or otherwise work hard to invent and create a product cannot easily recoup their time, money, and effort because others can just use what they have learned to make it. But with patents and copyright, creators sometimes gouge consumers because of what is essentially a monopoly power, particularly when it involves something essential to life or to a good life. Government and economic policies and business practices have an effect one way or another on who benefits and who is disadvantaged, but insofar as there is competition between businesses or between business and labor, or between business profits and consumers' best interests, there can be no neutral policy or practice. Ideally there need not be such adverse competition, but the ideal seldom occurs.
For now, however, I want to go back to Mankiw's original thought experiment and question two of his claims about it. First, not all voluntary transactions redound to the benefit of both parties. But for the sake of argument, let's assume that what the entrepreneur sells in this particular case does benefit the consumer, is good for him or her overall (unlike something like high fat, high sugar, high salt content food or tobacco that has bad effects and later costs), and the consumer remains reasonably happy to have purchased it and was not just an impulse buy or a regretted or problematic purchase made because of exploitative advertising or other sorts of social or psychological manipulation. The bigger question is how these transactions affect, or even skew, the economic system that allowed the original equilibrium.
If trade among all participants was such that everyone traded for what they wanted in a way that gave everyone the same amount of income (whatever that means in a case like this) doesn't the introduction of a new product that everyone buys, affect the system and alter the balance for everyone else, in at least two ways? Suppose that what made everything work before was that labor was divided in such a way that everyone worked approximately the same amount of hours and they all met each others needs through trading at least some of what they made for at least some of what others made. E.g., suppose a bunch of students join to make spectacular lunches for themselves at school, some making main courses, others, desserts, others veggies, others great soups, others great beverages, etc. Now if one student begins to make something all the others want so much that he can trade it for two of what the other students are making, and if everyone were already working at full capacity, then 1) s/he will be depriving some students of one or more of what they would have had because they are getting what the other student would have traded for, and 2) s/he will be in a bargaining position to offer others what they want if they make something s/he wants -- possibly taking their labor and previous products away from the other students. This may be fair, but it disturbs the equilibrium in a way that does harm someone at least temporarily.
Of course, the scenario Mankiw has in mind may not work in this particular way, but insofar as it would, he has not shown it meets the Pareto criteria, because the entrepreneur would be harming others as an unintended consequence or side effect of his/her success. In fact, I suspect, it is likely difficult in an interdependent society to meet the Pareto criteria in a situation where income starts to rise significantly for a relative few, because it will likely affect others in some adverse way, at least temporarily, unless there is help for the persons who are disadvantaged to be able to weather their displacement and/or become part of a new equilibrium (such as in providing paid job training for new work). The way most likely to meet the Pareto criterion, but most unlikely to occur, is for someone, or a group who is not making much of a contribution and not likely to, to go off by him/herself and build something away from society, in some sort of independent pioneer manner. The Pareto criterion in an interdependent society otherwise, I think, is not likely to be fully met, but more likely simply to be met relatively more by one form of activity than another. Mankiw's arguments work relatively better for any higher incomes which more closely approximate the Pareto criteria, since those higher incomes will less adversely affect the incomes or quality of life of others.
But there are other ethical considerations that need to be taken into account besides whether any group is harmed or not. One of those is fairness. There are a number of different kinds of unfairness that can occur and I want to talk about two of them in this paper: 1) unfair distribution of wealth based on uneven technological advance that accidentally favor one form of work over another, particularly when the favored work is less important in some significant sense that economics tends to ignore because it is difficult or impossible to quantify or to describe "objectively" apart from values, and 2) unfair distribution of wealth based on unfair wages, even if they are voluntarily agreed to.
Fairness of Technological Advance and Differential Incomes
Some labor can be "multiplied" by technology, particularly currently, digital technology. Others cannot. Sports and entertainment performances, for example can be recorded and/or broadcast to millions or billions of consumers, so that an hour's labor of a movie actor or professional football star can meet the demand of millions of potential customers/clients, whereas an hour's labor of a nurse, policeman, soldier, coal miner, and most school teachers cannot do that because it is extremely labor intensive and has to be personalized. It has always been open to a few teachers to make a lot of money from writing books, but books by themselves, and even internet courses with all kinds of video and audio presentations, don't serve to teach most people well, because most students seem to have a difficult time learning difficult material without a teacher present to monitor and guide them and adapt the presentation of the material to their understanding. This technological divide leads to hugely disparate incomes which often favor labor that is less important in some clear sense, such as the fact that the average NBA basketball player makes $5million a year compared with the average nurse's salary of $60,000-70,000. Spectator sports and entertainment are not without merit; they bring joy to many and particularly good movies can change people's lives, but for the most part, they do not rise to the level of importance of social benefit that nursing or police work or plumbing or any of a number of kinds of socially beneficial work requiring personal or individualized attention does.
And it is further not clear that the salary of a CEO, particularly of a company that is able to be global because of communication and transportation technology is fair to be so much more than the salary of those doing the manual labor in the same company that creates and distributes products, particularly in businesses where CEOs make millions and laborers in the company make barely enough to get by. That is essentially Darwinistic 'rent-seeking' by managers and CEOs at the expense of workers. E.g., it is not clear to me that consumers would not pay an extra dollar, say, per shirt if the dollar went to third world sweat shop workers who sew the shirt, who now make 30 or 40 cents per day for the work they do instead of to the sweat shop owner or the companies that sell the clothes. Mankiw writes: "Some of the largest disparities [of wealth] are observed between nations. If a national system of taxes and transfers is designed to move resources from Palm Beach, Florida to Detroit, Michigan, shouldn't a similar international system move resources from the United States and Western Europe to sub-Saharan Africa? ... Our reluctance to apply utilitarianism at the global level should give us pause when applying it at the national level." But 1) utilitarianism just says one should do the act that promotes the greatest amount of good, which may not be done by wealth transfers, so utilitarianism is not the culprit here, and any flaws in it do not negate the rightness of wealth transfers if there are other grounds for them. 2) There in fact are calls for wealth transfers (though not by that name -- but calling for fair pay and for not doing business with companies that unfairly exploit their labor force) from more developed countries to developing ones, but they fall under Mankiw's own "just deserts" principle, and illustrate the problems that mutual agreements can be unfair and exploiting, even if voluntary and that rules, regulations, or policies of some sort will have to favor either workers or ownership and that there is no middle ground when at least one side will not voluntarily do what is right.
And even if Mankiw is correct about the importance and social and economic benefits of the financing industry and the exceptional talent of those in it, apart from any successful rent-seeking that exists, it is not clear that supply and demand or economic Darwinism is the fairest way to determine incomes or the most effective way to get the best financial results. To say it works for the best for all, despite its flaws is to use the sort of utilitarian argument, Mankiw otherwise criticizes, often because it conflicts with "just deserts" or merit. But there are flaws with utilitarianism other than that it ignores just deserts; utilitarian acts or policies can also be unfair and they can violate rights.
I will return to the notion of fairness shortly, but because Mankiw mistakenly seems to think that the criticism of current distribution of wealth is based on utilitarianism, he misses the more important ethical issues with it. There are a number of flaws in utilitarianism (chapter 26 at http://www.akat.com/MeaningOfLove/introeth.htm), primarily that it cannot deal with fairness, with rights, reasonable distribution of benefits and burdens, and with desert. Mankiw sees the desert issue, and possibly the rights ones, but not the fairness one nor the most important part of the "reasonable distribution of benefits and burdens" issue, which is in part related to fairness.
The closest Mankiw comes to seeing the reasonable fairness of distribution issue is in saying that he had sufficient educational opportunity, equal to his own children's, even though his children have wealthier, more educated parents than he did. Mankiw's children probably do have more educational opportunities than he did if he is a good parent and if he has more knowledge of what it takes for them to succeed and how to expose them to that, and more contacts that would help them succeed if they have the genetic talents or predispositions he does. Still his parents were of a station that gave him sufficient opportunity for education and success. There is a sense of fairness of any sort that is based on having a threshold level of opportunity or of met needs, even if others have more. It is not just about marginal utility, which is what Mankiw mentions mistakenly as the criteria numerous times throughout the paper. It doesn't matter, for example, whether the marginal utility of a billionaire's next dollar in terms of his/her happiness is less, same, or more than the marginal utility of a poor person for their happiness. What matters is that a billionaire has far more than enough to survive on and live very well, whereas a poor person may not have enough to survive on or to do the things that people in certain economies ought to be able to do. No, one doesn't need the best or most expensive education to succeed, but one needs a level of educational opportunity, when such opportunities are possible and should be available, that gives one a reasonable chance to succeed if one doesn't squander the opportunity due to one's own fault. So even if Mankiw's children have greater educational opportunities than he did, it is not an unfair advantage, because he and his children are/were each above the threshold opportunity level to be successful and live a good life.
Inequality even in an interdependent society is not necessarily wrong. But it is if it avoidably is at the expense of those whom it makes unnecessarily desperate while others flourish with far more than enough to live well. In an interdependent society, insofar as possible, the necessities of many should be met before the conveniences or luxuries of the few are enhanced. If a CEO is far more than just wealthy at the expense of his/her employees having to live off a wage which is only at the level of subsistence, that is an unreasonable and unfair imbalance of inequality. Whereas on the other hand if someone has a 200 foot yacht while most others have only a 100 foot yacht, that is not an inequality worth addressing, unless it arises from cheating or other unfair practices.
There are other sorts of unfairness too; e.g., the fact that surgeons can charge so much more than policemen to save your life because they go to school longer, whereas a policeman may have learned his skills on the street or in the military while serving in combat. We think nothing of the fact that a liver transplant might cost $300,000 for a child who will die without it, but we would be outraged if an emergency crew, fire department, or police station said they couldn't send anyone to your neighborhood for less than $300,000 because it would save your life and because they had trained long and hard to be able to do their jobs well and save you. There is more to what makes inequality fair or unfair than just utilitarian considerations of the sort Mankiw addresses. And it does not take a complete theory of "fairness" in general to recognize different cases or forms of unfairness. Sometimes economists and other social scientists mistakenly claim that incomplete knowledge and/or disagreement about difficult cases means there cannot be any reasonable judgments about more obvious instances. Or they mistakenly think that science or reason can only apply to what is fully measurable in some objectively quantifiable way.
Mankiw does consider the claim that "the incomes of the rich do not reflect their contributions to society." But I think he misses the point in his response, which is correct as far as it goes, but doesn't go far enough. He says: "The key issue is the extent to which the high incomes of the top 1 percent reflect high productivity rather than some market imperfection. ...most of 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." The problem is that insofar as wages are exploiting and unfair, even if voluntarily accepted by individuals needing work, the market system itself is a moral imperfection that needs some sort of moral remedy. Redistribution of unfairly gained wealth is one such possible means for fairness. Redistribution of wealth is not necessarily unfair if the original distribution of it is itself unfair.
Mankiw recognizes the problem in regard to rent-seeking, but not in regard to simply taking advantage of workers in desperate situations. He says: "Steve Jobs getting rich from producing the iPod and Pixar movies does not produce much ire among the public. A Wall Street executive benefiting from a taxpayer-financed bailout does." (Since this was written, there seems to have been some public ire over the treatment of workers who make iPods, but I do not know how much or whether it helped improve the workers' situation or not.) The ire over taxpayer bailouts benefiting Wall Street executives is not because of successful rent-seeking. E.g., Apple makes a profit based in large part of patents that it aggressively defends, which is a form of rent-seeking, though a potentially fair and reasonable one, and people are not irate over that form of rent-seeking that leads to success if the patent is not abused or the consumer exploited by it. Reasonable patents are considered to be fair and reasonable for the most part, insofar as they help companies recoup their research costs for development and turn a fair profit. The Wall Street case causes ire because the people who caused the collapse of the economy that threw many people out of work not only did not suffer from doing so, and were not punished for doing so, but prospered by doing it, even without the bailout. And with the bailout, they prospered (even more), sometimes by receiving the tax money of those people whom they caused to lose their jobs and/or their homes. Insofar as that is what happened, that is very unfair. Even if there had been no bailout, it seems clearly morally wrong to allow people to prosper excessively who have caused such harm to others, particularly if they prosper excessively by causing that harm. And insofar as that is not considered a market failure, then the market system is itself, to that extent and in that regard, a moral failure.
Mankiw criticizes John Rawls' "original position" and "veil of ignorance" principles because they should not "supersede the right of a person to the fruits of his own labor." But what Mankiw is not seeing is that the incomes of CEOs and of management and stockholders are not the fruits of just their own labor (and in one sense, shareholders earn money without any labor in the company at all -- not making the product or selling it). When he critiques President Obama's point about how business is a collective enterprise, he takes it to be about government infrastructure and the relative contribution of the wealthy to its creation and maintenance in comparison with its contribution to their success. But I think he is missing the point because I think Obama misspoke in a way above and beyond the "If you've got a business -- you didn't build that" much publicized misstatement. Obama did (mistakenly or accidentally, or narrowly because of context, I think) use examples only involving government-provided infrastructure, but his larger point was that in our society much business success depends upon the work of others, not just one's own work: "The point is that when we succeed, we succeed because of our individual initiative, but also because we do things together." Apart from any contribution of government or social infrastructure, that is particularly true with regard to any major company that has a relatively large number of workers, particularly when many of those workers make in income an incommensurate fraction of the profits they help produce that helps make management incomes so much greater and shareholder profits so much more. The morally most obvious and egregious cases are those, which occur from time to time, where management gets workers to agree to reduced wages or benefits because of financial losses or because profits are seriously diminished, only to turn around and raise management salaries and benefits with the money they save from doing so. When that happens, it is unfair to the workers who help the company thrive. But that very same kind of unfairness in general is masked by the conventionally accepted myths that 1) supply and demand of labor determine a fair wage, 2) that voluntary acceptance of an offered wage is what makes income fair, and 3) that management is harder or ownership riskier, and that managers and owners have more important, or simply more, responsibilities than lower level workers, rather than simply having different responsibilities, and thus deserve more reward via a higher share of the profits generated by the company.
My view is that when someone helps you make a lot of money, you need to share with them a fair and generous portion of the profits they helped create. One example would be if actors help a producer create a film which is not expected to be a financial success, by working for a pittance, basically donating their labor to him/her because they believe in the project, but the film becomes a huge box office triumph. The producer should share the unexpected profits generously with the actors and crew that helped make it that way -- not rely on, or hide behind, the contract to avoid doing that. It is only fair to reward people for their contribution to the profits they help you generate. Mankiw says: "From the just-deserts perspective... confiscatory tax rates are wrong.... By this view, using the force of government to seize such a large share of the fruits of someone else's labor is unjust, even if the taking is sanctioned by a majority of the citizenry." That statement is just as true when it applies to the legal and agreed to "seizing" of an unfair proportion of the profits your workers have helped generate that should rightfully be theirs as the fruit of their own labor. It is no more morally right to keep an unfair proportion of the profit allocated to you by a voluntarily accepted salary coerced by supply and demand than it is to have to pay taxes legally imposed by a majority of legislators elected by a majority of other citizens. There is an ethics underlying business practices and economic policies that need to be brought to the surface and evaluated reasonably. Mankiw recognizes that and makes an attempt, but we can do better, and we should.
In case the link is no longer available, Mankiw's article was published in the Journal of Economic Perspectives--Volume 27, Number 3-- pages 21-34 (Return to text.)
Suppy/demand myth of fair wage:
This is wrong because it means one is not paid for the value of, or one's contribution to the earned profit for one's work, but is paid based on what others would charge in a bidding war for lowest accepted wage. If you help me earn an extra $50, what I pay you for that should be based on your part of the contribution to earning that $50, not on the fact that someone else would have done that same work for $5 or for $2. (Return to text.)
"Voluntary" in the sense it is used in this kind of context seems to mean something like "not coerced by the person making the offer", but does not take into account the plight of the person which may coerce him/her to have to accept it. As long as a person is coerced by circumstances, not by the prospective employer, that is too often mistakenly considered to be voluntary and fair even though it exploits the person's circumstances and takes advantage of him or her. That is potentially applicable to any transaction or "voluntary" exchange, though there are some (arbitrary or possibly excessive) cases where it is recognized by people outside the transaction as gouging or exploiting, or basically extorting someone whose circumstances place them "over a barrel" in regard to you. But once excessively low wages or high prices become some sort of norm, they tend not to be considered as being exploiting, except by some of the people who are being exploited because of their circumstances or by those who care about them. (Return to text.)