This Isn’t Your Grandmother’s Gilded Age

Anyone who sees these kids (except perhaps the average Wall Street Journal connoisseur, wherein this appears) might just want to smack their parents:

This is the story of when a BMW 7-series for your Sweet 16 just isn’t enough. This is the story of America’s young job creators treated not just with expensive preppy education, but luxury “Harry Potter themed hallways” and whatever that Batman room above, is. This is, incidentally, also the best way to socially stunt your teenage boys. That is, if they are expected to interact with normal people. But downward social mobility is about as nonexistent among the rich as upward social mobility is among the poor. So that means Richie Rich here can bet quite surely that he’ll continue to interact with America’s “creme de la creme”. Us plebeians are of no matter.

But this isn’t just a little bit of well-deserved snark. There is a deeply troubling socioeconomic reality that Harold Pollack briefly mentions:

Sometimes I wonder if George Soros or the Nation magazine doesn’t secretly produce these stories. From a broader perspective, the “Mansion” section provides a weekly Veblen-ian reminder that there’s one group of Americans who truly have so much money that they can’t figure out how to spend it, beyond purchasing bigger and more impressive monuments to their own wealth.  Our tax system might do more to help them address this problem.

Look, there’s nothing wrong with conspicuous consumption. And there’s a good chance that the same social ambition is a reason why America is as rich as it is. It incentivizes us to become like Bill Gates or Steve Jobs. But this only works to the extent that inequality isn’t deeply segregating the rich away from everybody else. Wait! This isn’t a leftist social trope: there are important economic feedback loops that will set the rich into an irreversible tailspin.

In a normal upper middle-class neighborhood driving around a high-end Mercedes and a Rolex watch might say something. Because living within feet of each other might be a teacher earning $50,000 and a doctor earning five times that. Kids at the local school are cliquefied as “rich kids” and “preps”. I go to Florida for spring break; you go to Monte Carlo. Positionality derives its value against middle America as a whole.

But as inequality creeps up – as it did in the last quarter of the 20th century – the teacher and doctor don’t live in the same neighborhood, anymore. The doctor lives in a special gated community. His neighbors are an annoying corporate lawyer, and a colleague from the pediatrics department. He doesn’t hang out at the city commons anymore, the country club is better.

So suddenly a Mercedes becomes old news. Flying coach to Monte Carlo is lame when the guy next door chartered a jet to a private island. So suddenly the doctor starts spending a lot more money for, as everyone should know, he’s no slouch… Positionality now starts to derive its value against upper America.

It’s not like the middle-class are exempt from this what really is an arms race. But they don’t have bottomless wallets. Their consumption tapers off at a reasonable level, and might even incentivize good hard work. But it’s an endless game for the rich. Suddenly the poor doctor drops off the map: the real doyens have moved off to a chartered township. And the competition within starts anew.

Now let’s say:

v = r + p,

where v is the value (price, in a competitive market) of a good, r is the “real” value, and p, is the positionality. Very crudely, r is what you’d pay for the same fancy, aged wine in a crappy bottle, p is the difference. Think p as a signal, of sorts. (Indeed you or I probably can’t even detect such high-frequency signals. Certain fancy tailors might have a signature cut that only card-holding members of the Veblen Club notice).

As inequality drives segregation, the real share of value (r/v) drops to nil, while positionality becomes everything. A first-class ticket, or country club membership are substantially better than the cheaper alternatives. But a shirt can only get so good before the signal dominates.

And if gross domestic product is the sum total of all final goods and services, to the extent luxury consumption grows in relative proportion, the positional share grows superlinearly. In other words, pure wastage is becoming a thing. Why is this wastage? I mean, according to the market, someone is deriving value after all. But it isn’t even Pareto-optimal. This is a strong statement. But in a small, model economy, if segregation is reduced – the rich can keep the same r with less p because they are competing against a more mundane set of people.

The economy can then reallocate the wasted capital on positional excess to that which adds real value. But this means someone is getting richer! And this means someone will want more positional luxuries! And this means sigma(p)/GDP is going to increase!

As you see, it’s a negative feedback loop. And that’s fine. But only if the government is willing to do its job and tax luxuries properly. The best way would be a harsh progressive levy on consumption after a level. This doesn’t disincentivize capital formation – indeed it will increase investment by expanding the market of loanable funds. People won’t be sadder, because I don’t need expensive positional goods if the person next to me doesn’t have one either.

Government can then use revenues to dampen segregative forces by providing solid education for the poor. Look, to some extent, the same logic can be used to speak of the Ivy League as a simple positional luxury. And it is. But the difference between an idiotic Batman Cave, or whatever the hell it may be, is that one incentivizes an incredible amount of hard work in high school, community service, and all kinds of other crazy shit people do to get into Harvard. The positional race has probably removed some value from GPAs and SATs as natural indicators of talent (i.e. the p/v is going up vis-a-vis the SAT – imagine a market where we can buy scores), but the overall concept of elite education today is relatively sound. And Pollack totally gets this right:

I’ve taught in elite academic settings for a while now.  Academic life being what it is, many of my students come from wealthy backgrounds. Children of the affluent can attend great high schools and extra tutoring. They can take unpaid internships. They can spend semesters abroad learning German. They can take an unpaid intern at Greenpeace or Slaterather than spend the summer waiting tables at Chili’s.

Some classic reading on the subject is Robert Frank’s paper, for Brookings.

At least in the old days, the rich princes used to travel Europe with Adam Smith as a tutor. Now they just seem like wasted minds at an early age…