The Economist Jun 17th 2013, 20:18 by M.S.
APPARENTLY someone, perhaps John Kenneth Galbraith, once said that the way to debate Milton Friedman was to wait for him to say “Let us assume…” and then immediately interrupt and say “No, let’s not assume that.” (Via Clay Shirky, via Dan Davies.) I thought of this quip on Saturday while reading a draft paper by Gregory Mankiw entitled “Defending the 1 Percent”. Mr Mankiw begins with a thought experiment: “Imagine a society with perfect economic equality…Then, one day, this egalitarian utopia is disturbed by an entrepreneur with an idea for a new product. Think of the entrepreneur as Steve Jobs as he develops the iPod, J.K. Rowling as she writes her Harry Potter books, or Steven Spielberg as he directs his blockbuster movies.” Everyone wants to buy the entrepreneur’s product, which results in a hugely unequal distribution of income. Should the government shift to a progressive tax system to reduce the inequality?
Obviously Mr Mankiw discovers that the answer is “no”, because that’s the answer he has built his analogy to produce. But you don’t even need to say “No, let’s not assume that” to see what’s wrong with this analogy, because Mr Mankiw has done a strange job of selecting his John Galt figures. Let’s go along with Mr Mankiw’s thought experiment: Steve Jobs, J.K. Rowling and Steven Spielberg are about to create their staggeringly popular products, which will increase inequality because everyone wants to buy them. But now let’s imagine that just before these geniuses are able to bring their creations into the world, they die. No iPod, no Harry Potter, no Jaws. What happens then?
Here’s what happens then. Instead of Apple dominating the market for MP3 players in the early 2000s, Sony and Samsung do; a little later, when smartphones come along, the battle for mobile operating ecosystems revolves around BlackBerry, Samsung/Google and Nokia/Microsoft. Instead of Harry Potter, some other children’s fantasy book becomes the dominant franchise of the 2000s. And instead of “Jaws”, some other movie becomes the first immense blockbuster of the 1970s, and a different brilliant director’s career is launched. All of the money that was spent over the past few decades to make Mr Jobs, Ms Rowling and Mr Spielberg immensely wealthy would instead have gone to three other hard-working creative geniuses, of which the world has no shortage. There would be just as much inequality as there is now.
In other words, Mr Mankiw’s analogy sneaks in his conclusion by implying that greater inequality is the price we pay for more invention and creativity. But his own choices of hero-entrepreneurs make it clear that there’s no evidence to support this claim. Of the three Mr Mankiw proposes, only Steve Jobs plausibly had an irreducible, unique effect on material culture and the structure of an industry. Mr Spielberg and Ms Rowling are acclaimed artists, but their startling wealth and prominence are entirely due to the increasing power of network effects in mass culture over the past several decades. Mr Spielberg happened to be directing his first movies just as Hollywood was beginning to stage coordinated marketing blitzes that created round-the-block lines for top-grossing films. Ms Rowling hit the bookshelves just as a similar superstar phenomenon was taking over publishing, with sales increasingly concentrated on individual mega-bestsellers rather than spread across a few dozen authors and titles. Mr Jobs is an unusual figure in that his ability to combine engineering, aesthetics, and a vision of how users might interact with the digital universe has created a kind of integrated multi-product entity that might not otherwise have existed; it’s not clear that BlackBerry, Nokia or Samsung would have been up to the task. But even in Mr Jobs’s case, much of the power that accrued to Apple was due to the gradual sorting of the consumer information-technology world into integrated ecosystems, a trend that would have taken hold over the past decade even if Apple had flamed out in the late 1990s.
It’s conventional wisdom that the entertainment industry has been in the vanguard of our increasingly superstar-oriented economy, with network-effect industries like IT and software close behind. Alan Krueger, head of the White House’s Council of Economic Advisers, gave a talk about this last week at the Rock and Roll Hall of Fame. “The music industry is a microcosm of what is happening in the U.S. economy at large,” Mr Krueger said. “We are increasingly becoming a ‘winner-take-all economy,’ a phenomenon that the music industry has long experienced. Over recent decades, technological change, globalization and an erosion of the institutions and practices that support shared prosperity in the U.S. have put the middle class under increasing stress. The lucky and the talented—and it is often hard to tell the difference—have been doing better and better, while the vast majority has struggled to keep up.” (Via Neil Irwin.)
So why does Mr Mankiw pick three figures from the entertainment and computer industries, where everyone knows the “superstar” phenomenon is strongest? Because if he used examples from other industries, it would be even more difficult to convince the reader that the immense rewards being reaped by those at the top had anything to do with their unique contributions to the economy. Last year the highest-paid chief executive in the country, at $131m, was a guy named John Hammergren, who runs a medical and pharmaceuticals business called McKesson. If he hadn’t been running McKesson, some other guy would have been. If Michael Vascitelli ($64m) hadn’t been running Vornado Realty Trust, somebody else would have. Perhaps those other guys wouldn’t have been as good at their jobs; in that case, these firms would have lost market share to competitors. So what?
The social purpose of high executive pay is to create incentives for hard work to maximise profit. But these guys are being paid double what their predecessors were making in the 1980s, which was not exactly a period known for its stodgy egalitarianism. Are we seeing startlingly better corporate performance today than we were back then? Is there greater productive innovation in, say, medical technology or commercial real estate? Is our economy growing faster? Are general standards of living rising faster? No, no, no and no. What public interest is served by the fact that these CEOs, as a class, are earning a multiple of what their predecessors did a generation ago?
Mr Mankiw’s analogy stacks the deck by making it appear as though great creative entrepreneurs create the consumer demand which leads to inequality. This is not how things work. Inequality is rising for structural reasons that have nothing to do with the social value produced by the labour of the top one percent of earners. If the government were to, for example, return top marginal tax rates to the levels that prevailed in the 1990s or the 1970s in order to compensate for the superstar effect, there is no reason to believe that the top one percent would produce any less value for society than they do now. Mr Spielberg would likely have worked just as hard at 1970s tax rates as he does at 2013 tax rates; indeed, he did so when he made “Jaws”. Similarly, Mr Jobs worked very hard on the Apple 2e in the 1970s and on the iMac in the 1990s, and Ms Rowling worked quite hard on the Harry Potter series even though tax rates in Britain are much higher than those in America.
To avoid accusations that I’m just picking out an ill-thought-out analogy while ignoring Mr Mankiw’s main thrust, I’ll add a few more points. Mr Mankiw argues that the calculus of progressive taxation is based on a confused utilitarianism. Whether high tax rates discourage productivity among the top one percent is the wrong question, he writes. Redistribution as such is misguided, he thinks, because we don’t have any good way to measure the increased utility which redistribution aims to create for low earners: “there is no scientific way to establish whether the marginal dollar consumed by one person produces more or less utility than the marginal dollar consumed by a neighbor.” This is strictly true, but I can’t see how it’s relevant in any normal society, where such compromises are made every time a law entitles citizens to equal treatment without trying to determine each person’s exact individual preferences. And it’s a particularly strange point to make in a paper called “Defending the 1 Per Cent”. We can be pretty sure that a dollar is worth more to someone who earns $30,000 per year than to someone who earns $3 million.
Mr Mankiw’s preferred alternative is a “just deserts” theory, in which people should retain the value of their labour beyond whatever is needed to provide public goods and compensate for externalities and market failures. “Confiscatory” tax rates, he says, should be avoided. This is one reasonable approach, but at the least, it suffers from the same calculation problem as the utilitarianism he derides: how much is a “confiscatory” tax rate, exactly, and according to whom?
But I think the worst weakness in the paper comes in Mr Mankiw’s brief treatment of the Rawlsian justification for redistribution. Rawls’s argument is that if people were asked what kind of society they’d want to be part of, without knowing whether they’d be rich or poor (ie behind the “veil of ignorance”), they would choose one where the rich paid taxes to fund social insurance for the poor. Mr Mankiw objects that this approach would also probably lead people to choose a society with mandatory organ donation, since they wouldn’t know whether or not they’d need an organ. He thinks this a serious flaw in Rawls’s argument:
If imagining a hypothetical social insurance contract signed in an original position does not supersede the right of a person to his own organs, why should it supersede the right of a person to the fruits of his own labor?
Why indeed? And how come when I break your window it’s just vandalism, whereas when I break your nose it’s assault? Because your rights over your own body are more fundamental than other kinds of property rights, that’s why. If Mr Mankiw is looking to dismiss the Rawlsian social-insurance argument, he’s going to need a better argument than this.