Sunday, November 8, 2015

Free Market Dogmatism Still Going Strong at the University of Chicago

On Friday I attended Thomas Piketty’s two appearances at the University of Chicago, my old stomping grounds, along with my good friend (and now, my coauthor!) Bernard Weisberger. I was eager to see the commotion in person because I was curious whether there would be any discernible acknowledgement on the part of his interlocutors of the huge challenges that Capital in the 21st Century poses to their worldview and their research agendas. And there was, if only in the vehemence with which they denounced Piketty’s arguments and insisted on shifting the terms of the conversation. In my experience, you can always tell when an academic feels his expertise has been exposed to public questioning and found wanting by the frequency of absurd pronouncements stated with ever-increasing confidence as they veer further and further from reality.

What follows is my account of the first event, a discussion between Piketty and two notable economists, moderated by a third. The second event, where Piketty more or less had the floor to himself to present Capital in the 21st Century, was by far the more substantive. Interestingly, the crowd at the first was tilted toward graduate students and faculty, in which context all parties articulated long-held positions and the audience was there to express solidarity with one or the other. The crowd was more undergraduate-heavy at the second event, where Piketty’s presentation presumed a deeper engagement with the issues at hand, and where the atmosphere was much closer to the ideal of free, high-level academic inquiry on an important public matter.

Piketty’s interlocutors at the first event were Professors Kevin Murphy and Steven Durlauf, with Jim Heckman acting as moderator. (He opened proceedings by announcing, in classic Heckman self-contradictory style: “It’s a debate! It’s not a debate—it’s a discussion. It might turn into a debate.”) I admire Professor Durlauf’s original research as well as most of his informal commentary, though not his review of Capital in the 21st Century in the Journal of Political Economy. I do not admire Professor Murphy. As was evident from his comments in Friday’s session, he worships free market economics as a religion, without any sense that its truth is contingent on reality. He further thinks that his 1992 paper with Lawrence Katz, which tried to explain the dynamics of the college wage premium in the 1970s and 1980s with reference to the supply and demand for skilled labor in the form of workers with a college degree, constitutes the final word on inequality in its methodological approach, its empirical conclusions, and its policy implications. Even if you consider that paper to have been correct in all of its particulars regarding the identification and interpretation of the fact pattern it aimed at (college wage premiums declined in the 1970s and increased in the 1980s), it simply doesn’t rise to the inequality-conversation-ending status Murphy believes it to have. Its model fails at explaining the labor market outcomes that have transpired since, especially since 2000—a period in which inequality increased vastly more than it did during the time Katz and Murphy covered, while the college wage premium only changed slightly—and that only because life got worse for non-college-educated workers, hardly evidence that the dynamic new economy provides ample benefits to those with the educational credentials to take advantage of them. The paper also begs the question at a fundamental level, a point Murphy reiterated at the UChicago session, when he declared that “technology causes growth, and in response to technology, we invested in physical and human capital.” Skills-biased technical change: the Ghost in the Free Market Economics Machine.

Beyond the empirical and methodological vacuity of that paper, Murphy’s way of presenting it is offensive in the extreme—and he tacitly aimed his arrows at Piketty. Murphy began with “let’s just do a little economics,” which he distinguished from accounting by saying that economists distinguish prices from quantities in calculating expenditure shares, a subtle dig at Piketty’s World Top Incomes Database (a far more important contribution to economics than anything Murphy’s done). To Murphy, “doing economics” means moving supply and demand curves around to tell a nice little story about how The Market solves every problem as long as it’s left alone.

Getting back to the “discussion,” there was no one theme. Piketty started things off by claiming that the received wisdom (at least among economists) for why inequality has increased, globalization and skill-biased technical change, simply don’t explain the phenomena very well. Neither can explain the rise of the top 1%, nor can they explain the international variation in the extent of tail inequality. Piketty did credit the role of educational exclusion in closing off access to the most elite precincts of the economy, as shown by the new Chetty, Saez, et al findings on the extent to which top universities draw their undergraduate students from rich households. But he continued on to a discussion of how the Piketty, Saez, and Stantcheva (2014) findings on wage bargaining and top income shares can’t be squared with a marginal-productivity story of wage-setting. He mentioned norms of corporate governance shifting in favor of managers and owners (the subject of the new excellent report from J.W. Mason and the worthy fellows and fellowesses of the Roosevelt Institute) by way of explaining tail inequality, as well as erosion of unions and the minimum wage as explanations for stagnant or falling wages at the bottom and middle of the distribution. He closed with what I consider a profound restatement of why Capital in the 21st Century is such an important book:
The gap between [the] official discourse and what’s actually going on is enormous. The tendency is for the winner to justify inequality with meritocracy. It’s important to put these claims up for public discussion.

Durlauf spoke next, and at first mostly inoffensively. He shifted the terms of the debate to focus on disadvantage within the US, something he knows a great deal about but which simultaneously takes the focus off Piketty-style tail inequality or the possibility that the two might be linked. He said, quite reasonably, that the key mechanism of inequality is segregation, because it translates individual inequality into entrenched deprivation, and that its policy implications are therefore to foster integration in a variety of contexts. That is all well and good (great, even), but in a Pikettian nightmare of tail inequality and patrimonial capitalism, all that matters is whether you know billionaires and are good at kissing their asses, and one thing we know about billionaires is that the people they like best are those most like themselves. No amount of policy-fostered integration matters in comparison to the social reality of that world. We’ll all be living together—in a slum.

Murphy’s presentation was where the wheels came off, intellectually speaking. He declared “we can do a lot with a little bit of economics,” then proceeded to do nothing at all of substance by regurgitating his 1992 paper. But according to Murphy, “that theory has done an amazing job,” including a cryptic statement about how it explains the rise of tail inequality “if you extrapolate,” whatever that means. Murphy closed by declaring that providing for adequate supply of skilled workers would benefit not only those workers who gain skills, but also those who don’t, since it would scarcify their labor supply—a direct recapitulation of the Hershbein-Kearney-Summers nonsense I addressed with John Schmitt here.

In the discussion that followed, Murphy stepped forward once again to declare that the economy’s “natural supply response of supplying capital” will help workers by reducing the capital share and increasing their productivity. This is a direct restatement of John Bates Clark’s old fairy tale of the rate of return on capital equilibrating in the long run to the benefit of all, so therefore we should never be so injudicious as to get in the way of that mechanism by taxing capital or those whose savings feed into it—i.e. the rich. Murphy’s use of the words “natural” and “technology,” which passed by the panel (and, seemingly, the audience) without comment, is notable here. Also notable is the fact that Durlauf asserted in his JPE review of C21 that no one thinks like Clark anymore, with his quasi-moralistic view of the efficient functioning of capital formation and the adjustment of its rate of return. Unfortunately, Durlauf’s empirical prediction was falsified by Murphy right there on that stage.

Later, Murphy added that in the absence of better education, “The march of technology over time means there’s little for someone with no human capital to do.” Astoundingly, that flagrantly question-begging just-so story garnered a round of applause from the audience, reminding me of the debate I attended in my first year of graduate school about the founding of what was then the Milton Friedman Institute, now the Becker Friedman Institute that hosted Friday’s event. On that occasion, various campus lefties from around the university protested inconsequentially against the institute’s namesake, and the presentation by economics heavyweights Heckman and Lars Hansen garnered competitive applause from the economics partisans present—not exactly a sign of reasoned academic discourse.

Meanwhile, Durlauf raised the oft-heard point that America just has a different ideology when it comes to progressive taxation, which is why expanding education is the route forward. (Durlauf even made the bizarre and obviously factually false assertion that “America never had a Socialist Party.” Eugene V. Debs got one in twelve votes in the 1912 election, as my friend Bernie, noted historian of Progressivism, pointed out afterward.) Fact-based and historically-minded as I am, I considered Piketty’s rebuttal devastating: that progressive taxation was invented in America and that it flourished here as a complement to free and equal quality public education, not a substitute. Together, the two did not destroy capitalism. Quite the contrary: the period of their efflorescence, complete with confiscatory estate taxation, saw the highest aggregate and per-capita growth across the income distribution of any time in American history.

Then things got weird. Durlauf replied by asserting that he didn’t mean to say that Americans had never been moved to oppose inequality, but that what mattered was their perception of its source: whether justified by merit, as in the case of Bill Gates, or extracted through monopolization, as with John D. Rockefeller. At that, Piketty quipped that Bill Gates certainly agrees. But Gates is rich because he has a government-mandated monopoly to sell operating systems and business software used almost universally, while Rockefeller was rich because of his interlocking monopolies on oil, railroads, and banking, and the fortunes amassed by both men endure because of subsequent capital accumulation. One of the best parts of Capital in the 21st Century is where he asserts (and, to my mind, carries) the argument that there’s no moral hierarchy of wealth.

Following a discussion of social mobility as the empirical analog of meritocracy, in which Murphy had his one good argument of the session when he pointed out, contra Chetty and friends, that there’s no reason to believe that a meritocratic society would generate perfect intergenerational rank-rank mobility, discussion shifted to policy. Piketty took the opportunity to return to the ghost of John Bates Clark by saying that we need a Plan B in case the “natural” capital supply response isn’t forthcoming or that it works against rather than in favor of workers—namely progressive taxation of wealth. “Otherwise, it’s a bit magical.” That set Murphy off. He interjected that he never meant to say problems of inequality would solve themselves. But, on the other hand, progressive taxation is the worst thing you could do—shut down that supply response by destroying the incentive to save to form physical capital or to get educated to form human capital. Referring to some version of Mitt Romney’s old friends, the Makers and the Takers, Murphy quipped “we have to keep people engaged”—presumably meaning that without the goad of vast inequality to spur them to action, the left-behind might just drift out of the economy altogether. That roused his followers in the audience once again. Continuing on his lifelong quest to preach the gospel of the First Welfare Theorem to the expectant congregation gathered at the camp revival, Murphy continued [referring to the poor and marginalized] “People aren’t perfect. They don’t all look out for their own interest but most do.”

The intellectual and doctrinal muddle is almost too tangled to tease out here, but the idea seems to be that the poor, benighted though they are, will adopt the morally correct position of looking out for their own interest by acquiring an education, so long as the incentive to do so is preserved by avoiding progressive taxation. Usually the fallacy in the moral philosophy of economics, for those who partake in such things, is to argue that whatever reality exists is for the best, a classic Panglossian is/ought conflation. In this case, though, the “ought” is a priori: people should be selfish. For that reason, they probably will be, so long as the status quo is maintained as an instructive lesson in the disaster befalling anyone not born rich. At least Murphy disagrees with the late Franklin Giddings, the Columbia professor who said in 1893 that following 20 years of populist agitation, American farmers hadn’t managed to improve their economic position and therefore must have only themselves to blame. Murphy, on the other hand, holds out hope of future bootstrap-pulling-up behavior so long as we avoid the pitfall of directly addressing inequality as we find it. Piketty himself said it best: “The idea that we need to keep inequality to preserve incentives is just not consistent with reality.”

Durlauf made a final, inscrutable point in this debate by saying that we should directly address the harms caused by inequality, by which he was referring to capture of the political system by the wealthy—as opposed to dealing with inequality itself, through progressive taxation, presumably. He asserted that the former approach is what motivated Progressive-era reformers, a remark that elicited an audible scoff from Bernie.

That ends my account of the first session of the day—disappointing in the extreme, an opportunity to relive the worst aspects of my experience in graduate school. [Thankfully, a tiny minority of my time was spent listening to Kevin Murphy lecture, but I honestly was scarred by and still resent the nights I spent working very late to gin up the answers he wanted for his flagrantly ideological problem sets.] The saving grace of Friday’s event was of course Bernie’s company—to which I fled more than once in intellectual desperation during my PhD.

In Durlauf’s JPE review, he mentions that Charles Murray (and specifically his book The Bell Curve) has no influence in academia, even though it retains a totally undeserved hold on public debate. Durlauf is implying that Capital in the 21st Century merits the same fate, which is a totally ridiculous and offensive comparison. In any case, Murray came to UChicago on his book tour for Coming Apart, and that event garnered no attention whatsoever from the economics establishment (except for me—I wrote it up at the time on my Facebook wall, an account which can be read here.) Indeed, one of the aspects of Washington economics discourse that has surprised me the most is the relatively high stature accorded to Murray, Brad Wilcox, and their “pro-family” nonsense by elites here (notwithstanding the yeoman’s work of the great, and tireless, Phil Cohen, showing what charlatans they are.) The right wing of academic economics doesn’t give Murray and Wilcox the time of day, but apparently it worships the ground Kevin Murphy walks on, despite the fact that Murphy has no greater claim on our attention than Murray. They are both fact-free ideological axe-grinders whispering comforting, apparently-superficially-plausible nonsense to the powerful.

Blume and Durlauf Review Capital in the 21st Century

Professors Lawrence Blume and Steven Durlauf have a very critical review of Capital in the 21st Century in the August Journal of Political Economy. I think they may have taken the bait Piketty dangled in front of the economics profession by couching his explanation for inequality dynamics over time in the costume of neoclassical macroeconomics. The more I consider Capital in the 21st Century, the more I think Piketty may have executed the most brilliant matadorial maneuver in the history of economics by using neoclassical machinery to argue that capitalism generates high inequality. That induced the economics bull to charge Piketty's red cape, but when the dust finally settles, it's the neoclassical machinery that's been gored.

Blume and Durlauf spend a lot of time attacking Piketty's neoclassical model, but then on pg. 761 they concede the crucial point by saying there are all sorts of reasons why factor prices need not be determined by marginal conditions in reality. They return to the theme in the discussion of the "supermanagers" in the wage inequality section, where they contort the meaning of marginal productivity to be consistent with any observed wage bargain.

The authors also make a play for the argument that inequality doesn't matter under current circumstances because the absolute wellbeing of the poor in rich countries is adequately high, and that certain absolute advances will be reversed only under "bizarre scenarios." They elaborate:

Fogel (2004) makes an argument that improved nutrition played a major role in the attenuation of economic inequality because it allowed the disadvantaged to qualitatively increase labor force participation and effort at work. These phenomena are not going to be reversed any more than mass vaccination or other medical advances will be.

Durlauf is usually among the most historically informed of prominent contemporary economists (unlike some people), and his references to history are, on the whole, probative. But that statement is profoundly ahistorical. I was planning to list examples of past demographic collapse arising from economic dislocation, but then Case and Deaton came along last week and brought a case of it to public attention for me. [Though the truth sounds like it might be less disastrous than Case and Deaton make it out.]
More generally, people have gotten absolutely worse off all the time in history--specifically, when they lose power to rapacious conquerors and other agents of exploitation. That not only could happen--it is happening right now. The return of aristocracy is an empirical phenomenon we observe! To say "this could never happen, which I conclude because we don't have Dukes and Earls" is just stupid. It's also bizarre for Durlauf to say it, because he has written about the "puzzle" of why inter-group inequality has not attenuated over time. Well if gaps stop closing, wouldn't you think it might be possible for them to re-open? Blume and Durlauf accuse Piketty of engaging in "Whig History," a false comparison, but their own strange arguments about the impossibility of historical retrogression suggest a similar tendency in themselves.

Returning to the wage inequality section, the authors seem not to be aware of Piketty, Saez, and Stantcheva (2014) (the "three elasticities" paper), since they say Piketty has done no original research on wage determination of top incomes, and that he is "careless with theory, and empirical evidence is presented in an unreflective and selected fashion." Piketty is nothing EXCEPT reflective, and the research he doesn't present is the stuff he thinks is crap. This isn't a Handbook of Inequality Economics, because if it were he'd have to include a lot of shit.

In the Policy section, Blume and Durlauf say Piketty considers no policies beyond capital taxation and ex-post redistribution. That just fails to even consider the arguments he makes throughout the book that taxation affects the ex ante distribution of both capital and labor income. In fact, the whole book could be interpreted as making that argument.

In short, Blume and Durlauf's review reads like it was written in a fit of pique, and it's a little tough to see why, though part of it is sensitivity to Piketty's own public questioning of the economics establishment, and specifically the work of Gary Becker. There have been other attempts to write Capital in the 21st Century out of respectable academic debate, a maneuver attempted once again at Piketty's appearances at the University of Chicago on Friday. I'd wager they won't be successful, thank God.

Monday, October 5, 2015

How much would increasing top income tax rates reduce inequality? Good question.

Last week, William Gale, Melissa Kearney, and Peter Orszag (henceforward “GKO”), all of the Brookings Institution, published the result of a simulation ostensibly showing that increasing top-bracket ordinary income tax rates would have little impact on inequality. Unfortunately, their negative conclusion arises more or less automatically from the measures of inequality they report, which do not capture variation in inequality in the tails of the income distribution very well. This morning, John Quiggin made that point, which I expand on below.

The specific scenarios GKO model are increasing the top marginal tax bracket from its current 39.6% to either 45% or 50% and rebating the revenues to low-income households. Their primary analysis simply quantifies the mechanical effect of this policy on income inequality, assuming no behavioral response to tax changes. In this discussion, I confine my attention to the effect of the tax increases on tail inequality and do not discuss the issue of redistribution.

There are two key reasons why these tax scenarios do not affect inequality very much. First of all, the rich earn a great deal of their income in categories other than “ordinary income,” to which these tax rates apply. Those categories are grouped under the somewhat-misleading heading “capital gains,” though tax advisors are skilled at re-categorizing many things to fit the broad definition. This is the nature of the controversy over the “Carried Interest Loophole,” a tax shelter available to employees of Private Equity, Venture Capital, and Hedge Funds—meaning that the beneficiaries of that loophole, who increasingly comprise the top 1% and top 0.1%, would be significantly shielded from the GKO scenarios. News stories in recent years have focused on the low effective tax rates paid by Mitt Romney and Warren Buffett, precisely because those very high-income individuals avail themselves of those loopholes. By looking only at tax rates on ordinary income, the Brookings scenarios ignore them.

The other reason why this scenario doesn’t do much for inequality is that GKO measure inequality by the Gini Coefficient. But the scenarios only affect individuals comfortably within the top 1% of the income distribution. The top tax bracket kicks in at taxable income of $457,601 for married couples filing jointly, which is above the threshold for the top 1% of the taxable income distribution. The Gini Coefficient is insensitive to measuring inequality in that group. That is why Thomas Piketty and his many collaborators on the World Top Incomes Database focus on measured top income shares. Other measures of inequality that GKO consider, like the ratio of 99th to 50th percentile income, are also inadequate for the same reasons. Indeed, one of the authors, Orszag, conceded as much on Twitter, and Lucas Goodman, a graduate student who worked on the analysis, made a similar point on his personal blog as well.

Using data that Goodman kindly provided to my colleague Ben Zipperer, it’s possible to estimate what happens to inequality as measured by the top 1% income share under GKO’s scenario. Goodman reported the Gini Coefficients in GKO’s after-tax income data for both the bottom 99% of the distribution and for the distribution as a whole, either under current tax law or under the GKO scenario of increasing the top bracket rate to 50%. Using the formula for converting partial distribution Gini Coefficients to top income shares derived by Alvaredo (2011), it appears that the policy would reduce the top income share in GKO’s data (after-tax income distribution of tax units) by about one percentage point. That drop is actually quite substantial. The context is not precisely the same, but for comparison, the Congressional Budget Office estimates that the after-tax income share for the top 1% of households increased by a total of 5.2 percentage points between 1979 and 2011, so the reduction in the top 1% income share as a result of the GKO scenario is just under 20% of the total increase in inequality over the whole period the CBO analyzes—a much more substantial impact than the one highlighted by GKO.

GKO are continuing a debate that played out this past year concerning policies that would combat income inequality and wage stagnation. At a public appearance sponsored by the Hamilton Institute in February, Lawrence Summers said that focusing on education is a distraction from the challenge facing workers, which is that “there aren’t enough jobs.” The following month, he, Kearney, and Bradley Hershbein published an analysis that argued that a 10% increase in the share of men with college degrees would not substantially impact tail inequality. John Schmitt and I commented on that analysis here, and the authors responded here. All of us agreed with the conclusion that dramatically expanding higher education attainment would not affect inequality very much because it wouldn’t impact the tail of the income distribution. Now, in essence, GKO are saying “well, sure, education wouldn’t affect tail inequality, but neither would higher taxes on the rich,” and they’ve constructed a scenario and employed ill-fitting metrics to support that rhetorical move.

A final word about behavioral responses: the most important research on the effect of top marginal tax rates on the behavior of those liable to pay them is the recent paper by Piketty and his coauthors Emmanuel Saez and Stefanie Stantcheva (henceforward “PSS”), which my colleague Nick Bunker summarized here, and which I discussed before here. The paper describes three elasticities by which top tax rates affect economic behavior. Aside from the classic “supply-side” elasticity, which conjectures that people work less when they’re taxed more, there are two additional responses. PSS’s second elasticity (not original to their paper) is the re-categorization of labor income as capital gains or some other tax-preferred category, and their third elasticity (which is their original contribution) is that in response to higher taxes, rich individuals face a diminished incentive to bargain for a share of the corporate pie.

If the scenarios GKO model were in fact implemented with no other changes, top-bracket taxpayers would enjoy an even larger incentive to re-categorize their income as capital gains than they already do, limiting the ability of such rate changes alone to affect inequality without also tightening up the loopholes available to the rich. On the other hand, they would also have less reason to bargain hard in wage negotiations, which would increase the effect of such a policy on inequality. PSS provide evidence that the third elasticity is more important in explaining behavior than the second. Furthermore, they show that declines in top marginal tax rates across countries are the primary driver of rising tail inequality, implying that a reversal of that policy would have the opposite effect. These questions are far from settled in the literature, so future discussion of the effect of top tax rates and the tax system more broadly on inequality should aim at confirming or disproving the arguments in PSS, not on scoring rhetorical points.