Thursday, October 9, 2014

Inequality and the Fourth Estate

I have been slow to chime in on Thomas Piketty’s book, Capital in the 21st Century, but it is hard to ignore the chatter that the book has generated from those on all sides of the political spectrum. The book sheds welcome light on the topic of income and wealth inequality and it has rekindled a debate in the United States and Europe on an age-old question: Should we care if some individuals earn much more than others?

As individuals in a modern democracy we make social decisions about how much of each good to produce and consume through free trade in a market economy. The rules by which we trade with others are determined through democratic elections in which we give power to our representatives to transfer resources from one human being to another. And we interact with each other through conversations, free association and social media or through more organized forms of persuasion such as newspapers and television stations. 

As economists, we are sometimes justly accused by other social scientists of taking a narrow view of human nature. A human being, to the neoclassical economist, is a preference ordering over all possible actions that he or she may take over the course of a lifetime. That preference ordering is fixed at birth and swings into action at the age of consent, at which time each of us exercises our endowed ability to choose among competing alternatives to maximize our happiness. 

That, of course, is poppycock. The view of homo-economicus as a utility seeking machine is not to be found in Smith, who had a much richer view of human nature as evidenced by his “other book” on The Theory of Moral Sentiments. Nor is it to be found in John Stuart Mill’s eloquent defense of free speech in his essay On Liberty. Both of those eminent social scientists would, I am certain, have been open to the idea that our opinions are formed through rational argument with other human beings. Our preference orderings do determine our actions; but they are not preordained. Nature and nurture are equally important determinants of human action.

Politics and economics are two parts of a theory of social democracy. There is a third component of social theory which Thomas Carlyle referred to as the fourth estate. In Carlyle’s day that referred simply to the press. In the 21st century, it is any technology that promotes the spread of ideas.

Elections are not simple horse races between differing opinions, they are heavily influenced by advertising paid for by political machines that raise money from competing interest groups. The NY Daily News reported, in 2013, that a US Senate seat now costs $10.5 million to win. It is difficult for me to believe that this money is spent to endow potential voters with facts that they need in order to inform their own preexisting preference orderings over outcomes. Money buys votes by shaping opinion.

The power of money to influence elections suggests an answer to what is otherwise a perplexing question. Why are taxes on large estates currently set at such low rates? After all, we live in a democratic society in which the rules of the game are set by elected representatives in which every U.S. citizen gets one vote. Further, as Piketty reminds us, 1% of the U.S. population controls 30% of the wealth. Why don’t the 99%, as a matter of course, choose to confiscate wealth from the richest 1% of the population?

The conservative answer to that question is that “a rising tide lifts all boats”. According to that argument, a confiscatory estate tax would result in lower growth and all of us would be worse off. It is difficult to know if that proposition is right or wrong but the evidence from Scandinavian social democracies suggests that it is at least debatable. And for a substantial period of time following the end of WWII, growth did indeed benefit all parts of the income distribution. What Piketty has shown us, incontrovertibly I believe, is that since 1980 or thereabouts, it is only the rich and the very rich who have benefitted from growth. 

The rise of democratic institutions in nineteenth century England, was a response to the redistribution of wealth from landowners to the growing middle class that was created by the industrial revolution. Democracy was a safety valve that enabled the social cohesion necessary for everyone to thrive and it resulted in a massive redistribution of wealth from the landed aristocracy to the rest of society. That same safety valve will eventually lead to the enactment of a more comprehensive policy of redistribution as voters realize that there are limits to the argument that greed is good.

One can make moral arguments for or against the redistribution of income and wealth but at the end of the day those arguments only matter if they are persuasive to the average voter. In a democratic society, the power of money to influence public opinion can perhaps hold back the tide for another decade. Maybe it can hold back public opinion for two or more decades. But there will come a time when the average American realizes that the dream that his parents aspired to is no longer within his reach. And at that point, the enactment of a more comprehensive estate tax is inevitable.

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