I’ve been thinking a bit about why wealth inequality really doesn’t matter – but I think the argument is a little more nuanced than I presented. In particular, what I wrote yesterday is concerned largely with the positive, but in reality this debate is intimately connected with normative action. In the wake of Piketty’s book (which I have not finished) a number of people are talking about taxes on global capital.

I don’t have a very strong opinion on that (other than a negative gut reaction). But there are things we can do closer to home – appealing to both conservatives and liberals – that would be more feasible and possibly more effective. In this debate we are faced with a slurry of terms that are sometimes used to describe the same underlying phenomenon but are each different: wealth, capital, returns on capital, and capital share of income.

While I am unconvinced that just the inequality of net worth (“wealth”) really does much harm to a nation’s socioeconomic fiber – indeed I think concentrated wealth is probably a necessary consequence of capitalism – it is clear that skill-biased technological change, and what that portend’s for labor’s share, is probably an important concern (if nothing else in the discussion of income inequality itself).

And here’s the problem. Government programs, the way they are currently structured, are largely to blame for gaping disparities like this:

(Before I go on, it is worthwhile noting this picture, yet again, confirms my previous point that wealth inequality per se isn’t increasing and was never a problem).

What we see isn’t surprising. The bottom 90% of Americans are basically excluded from the stock market – the most important source of long-run returns for pretty much everyone else. What’s striking here is that this inequality is far worse than inequality of wealth itself. So not only do the rich own more capital, they own the best capital.

To some extent this is unavoidable. Rich, well-connected elite have far better access to the best investment opportunities like secondary private markets and hedge funds that provide alpha. (Chances are if a hedge fund is doing well accounting for management fees, they don’t want you as a client). But the people that benefit from this are the extremely wealthy percent of a percent not even demarcated above, not simply affluent Americans who are still extremely well-represented in stock markets as a whole.

And the reason for this? Perhaps poor government policy.

The real wealth of most Americans is their claim on social security in the future. Social security has been an incredible source of, well, security for many citizens and pretty much the reason many are not in poverty today. But the Social Security Trust, which actually handles all of this money, is basically forcing you to invest in low-return government debt.

This becomes a source of inequality as social security as a portion of total implied wealth (here defined as your claim on future GDP) is far higher for the bottom 95% of Americans, who can barely save, than anybody else. On the other hand, for people that actually manage to save (even if just a little bit) the stock market is a source of real, long-term prosperity.

Furthermore, misguided government programs encouraging homeownership – something many economists have come to agree isn’t a good thing for poorer people – once again distorts private investment choices to relatively low-return stores of wealth like residential real estate. When the productivity growth is coming from financial, informational, and social capital, what value is owning a home in Podunk, Missouri?

Again, mortgages are the primary – and possibly only – source of explicit wealth for middle-class Americans.

Many conservative economists have reached the conclusion that we should probably privatize social security. As a purely financial matter, I am inclined to agree – the justification for our current program is fully predicated on the dangerous assumption that government bonds are the best long-term investment when, in fact, Vanguard Target Retirement 2045 is the way to go.

In fact, what we need is something akin to a Sovereign Wealth Fund that allocates payroll tax receipts in a more productive way. This should have great appeal to conservatives as well as liberals. For conservatives, it frees an immense source of domestic equity away from relatively inefficient projects furnished by the national government to more entrepreneurial and productive ventures in private markets. Indeed the cost of capital (in normal times) would probably fall. For liberals, it is the most logical extension of the welfare state, designed in a way complementary, not opposed, to modern capitalism.

This would solve what I see is the heart of the problem Ezra Klein and others are getting to when they worry about wealth inequality. It isn’t the disparity of wealth itself (which is background noise), but the changing structure of the returns. It is a tragedy that over the past thirty years, the stock distribution was so much more skewed than wealth distribution.

The government is ultimately a bank that can print its own money. What it should be doing is guaranteeing a minimum return in future receipts, as it does today, as well as investing in the option for more explosive growth. If the stock market performs so poorly as to not provide the returns necessary for to meet the obligation (and there’s a very low chance this would happen over the long run) the government can always finance the difference with a deficit. In fact, since returns would be far higher, chances are in a financially-driven recession, the increase in deficits would be lower.

This is probably not enough, but does more to solve inequality than a meaninglessly small increase in capital gains taxes would accomplish. More importantly, it achieves this without further harming private interests, and yet greatly increases capital redistribution. It would also unleash an incredible amount of capital for the investment the private sector desperately needs.

Here’s the short and sweet argument for privatized, but guaranteed, security. Rich people should give poor people equity in their companies rather than taxes to the government to solve issues of capital return disparity. The only role government should play is effectively guaranteeing a minimum return, in other words purchasing a barrier put on the S&P in the event valuations fall below what is promised. That is cheaper, more efficient, and the principle we ought to work on.

Ezra Klein’s remarks on inequality led to a pretty rich discussion, for the most part, disagreeing with his proposition that inequality isn’t the defining challenge of our time. His response today is great, making a clear – and agreeable – case that full employment is the most urgent problem facing policymakers today. The problem, I think, is that this still conflates importance with urgency and that which implies the former most certainly does not so the latter. Most of his recent post is correct. Unemployment is depressing median wages and absolutely nothing is more important right now than job creation.

But I want to focus on another, somewhat tangential, part of his post. Ezra writes:

Within the general rubric of “inequality,” income inequality gets a whole lot more attention than wealth inequality. But wealth inequality is much more concentrated and, in various ways, much more dangerous for the social structure. In particular, it’s wealth inequality that really ossifies social mobility.

The children of the top one percent only occasionally manage to match their parent’s incomes. But they often receive massive inheritances that grow over time, installing them atop the economic ladder and giving them a political reason to fight like hell against progressive tax policies (the Walton family is a good example here). And this kind of inequality doesn’t have any of the salutary benefits of income inequality: Massive inheritances don’t make people work harder. They give them a reason to never work very hard at all, and to try to influence public policy so they never have to work hard in the future, either.

I’ve written something along the same lines before, but have revised my belief that wealth inequality is an important signal. I’ll first detail why I think wealth is not too important before noting some reasons why it might be in the future. For one, wealth inequality has almost always been bad and – unlike income inequality – is not showing significant deterioration. In fact, the richest one percent actually saw a decline in their power over the Clinton boom:

Of course, the wealth Gini is at any given moment in time “worse” than the income Gini, but that’s like comparing apples and oranges. To consider why think about how wealth and inequality thereof accrues: savings and investment. At any arbitrary level of income inequality, wealth inequality will increase, with a higher propensity to save among the rich as the first order effect (and capital gains as an important feedback). 

It’s pretty shocking how static wealth distribution has been, then, given the increasing income inequality. It’s difficult to argue then that wealth inequality – which is hardly a changing feature, unlike income – actually matters for political process in the way Ezra suggests. As disgusting as the Walton family’s politics might be, they have if anything only ossified the existing wealth inequality, without any first order effect on income (as Ezra points out, why should useless trust fund babies care about income taxes when they aren’t actually doing anything productive enough to earn seriously). Arguing that it is important that wealth inequality ought to be more important by arguing that wealth inequality engenders policies to protect wealth inequality is begging the question.

A focus on wealth also obscures monetary policymaking. Quantitative easing almost certainly increases wealth inequality, though there are good reasons to believe it improves income inequality (which over the long run would decrease wealth inequality… as you can see the interplay and economic dynamics are complicated to say the least) through a tighter labor market. In fact, one reason why monetary policy over the past decade did not increase wealth inequality as much as it could have is America’s expensive, pro home ownership programs like interest deductions and guaranteed loans.

In a freer real estate market – one that many economists agree would be more efficient and fraught with less moral hazard – it is likely that homes ownership would be more concentrated, with much of the middle class renting from the rich. The easy money policies of the early and late 2000s, then, would have increased wealth inequality that much more. But that would not mean anything, and should not be the basis for any policy action.

On the other hand, some important things are changing and wealth inequality may be more important in the future. As Piketty and Zucman document in a must-read paper, the wealth-to-income ratio in rich countries has increased substantially over the Great Moderation challenging conventional economic wisdom that this ratio is constant over time and reflecting lower population and productivity growth coupled with higher savings.

However, their data is a lot less remarkable for the United States, where population growth is relatively robust, and savings low – the ratio has increased though not markedly so. Still, in an age of automation and increasing capital shares, the increasing ratio could become an important economic issue.

Ultimately, though, capital income is still income. The return of wealth is not as much a reason to worry about wealth inequality but for capital tax parity with income – something progressives worried about income inequality have long advocated.

The importance of wealth inequality boils down to this. It is difficult to argue, as I think Ezra does, that this matters in and of itself because wealth inequality has historically been around as high as it is, and few would have suggested this is a problem a few decades ago. Suggesting that high wealth inequality begets more wealth inequality is not just assuming the conclusion (that this is bad) but also is not empirically guaranteed (though I am less convinced of this, data show that the 1%/median wealth ratio has increased substantially).

The arguments that wealth inequality matter for other reasons go back to some form of income inequality, usually distribution of capital gains. These are central to debates about inequality of all stripes. Wealth is not at all irrelevant, though. Flows matter more than stocks but when we as a society realize that deeper safety nets and education for the poor are important, we’ll tax the flow of inheritance every year instead of income which is scarce relative to the flow of wealth.

The latter half of the 20th century was a great time for American liberalism. Our big, but more or less market oriented, government – for the first time – used public policy as a means of substantially curbing inequality across the country. The story of postwar America was of the middle-class autoworker living a good life.

There are economic reasons to doubt that we’re reaching a crescendo in the era of increased polarization: skill-biased technological change being key among them. But the more pressing issue is social, political and, unfortunately, broadly unmentioned. Perhaps the ferment in economic structure due to automotive and other technology played an important role in creating the new middle-class.

However, it is indisputable that Roosevelt, Truman, and Eisenhower era policies of very high taxes and public spending played an even more important role. Most Americans today cannot comprehend the extent to which the Federal Government was involved with economic life just two generations ago.

In a democratic society, this implied incredible political will to create progressive institutions. I have little doubt that if we wanted to, policy could cure inequality with a broad enough mandate – like that given to Roosevelt.

But this obscures something important. The Great Recession might have been the worst economic event in American history since the Great Depression. But it wasn’t the Great Depression. Living standards for the median and poor in America might be at their relative minimum since the Great Depression. But not their absolute minimum.

To understand the difference between then and now, citing GDP per capita is just not enough, because the mean blurs tail skews. In 1933, the average income for the bottom 90% was less than $7,000 dollars. In other words the average Chinese (who is very poor, by the way) lives much better today than most Americans did then.

The political will in a democratic society to vote to eat, be clothed, and provide for your children is very strong.

The equivalent figure today is over $30,000. Sure the rich today are unimaginably wealthier – but that doesn’t change the evaporation of fundamental want.

This is to say that we may never again see the political will from the country as a whole necessary to employ policy to curb inequality. This is to say that the Kuznets Curve for inequality in democracies might well be bimodal.

Peter Orszag here considers the interesting and recent phenomenon of taxi drivers with college degrees. Tyler Cowen adds comment here. Let’s consider a few stylized facts about the emerging labor market:

• There will be stark inequality.
• College grads tend to be underemployed or unemployed unlike ever before.
• Without good luck, you can expect to graduate with not insignificant debt.
• There’s something about this “knowledge economy” thing. It’s probably good if you can take a derivative functions, and such.

There are two ways to have this conversation. We either talk about the “new economy” where paying the big bucks for an English degree isn’t worth it, but also where you can get a full computer science degree from a top school for less than $8,000. Or you talk about the “old economy” where people still care about the vanilla Bachelors. For signaling if nothing else.

I think Orszag, and too many others, speak in a hybrid construct; a mongrel between the old education and new labor market. That’s very understandable, because this is where we are today. Still, it’s broadly not a very useful discussion. The point of this post isn’t to pontificate about the future, but give some concrete predictions on college education vis-a-vis the labor market.

Here’s the money word: bundling. College, the experience, is contrary to popular belief mostly a consumption good. We’ve successfully disguised it as investment because the relatively small portion of it that was yielded huge dividends between 1950 and 1980. Bundling worked in this context, because the experience aggregated many different goods (English 101, Econ 102, etc.) into one. The consumption value of college exists today, but the economic fundamentals behind bundling do not. Here are features of a successful bundle (like pre-Netflix TV):

1. Relative economies of scale and scope.
2. Opportunity cost of bundling is low.
3. Very high barriers to entry.
4. There’s value from the bundling itself.
5. And, most importantly, heterogenous demand. Technically, this means that for two agents, demand for components within the bundle are inversely correlated (you like Math relative to Physics, and me vice-versa).

(1), (3), and to an extent (4) probably will still exist in some form. But the opportunity cost of bundling will no longer be low. Bundling means a university has to congregate PhDs for about a 100 different fields within a physical locale, provide them with good salary, a good number of them with tenure, and all of them with good research activities. For teaching schools it means somehow convincing a PhD to get off the “publish or perish” mindset. For research schools it means ensuring strong research opportunities exist, for all disciplines.

Then you have to add agglomeration effects, which work deeply in favor of Harvard and MIT over a random university. If I’m a hotshot with a PhD in Math from Princeton, where do you think I want to go? (Hint: not Utah). All of this makes the non-established university, meant for the non-established students, an incredibly expensive operation. It’s been worth it, until a decade ago.

But things are worse today. Young whippersnappers today don’t want to learn from a third-rate professor in a lecture hall of 500. They can learn from, quite literally, the ustads of a field from online ventures. Yes, there’s a lot of skepticism about that today. But to the extent the new, “knowledge economy” is everything people fear, online education in its best form will exist. In the next ten years, highly versatile technologies will exist allowing students to interface across the globe in ways we can’t imagine.

How can a current bundler, with its non top tier professors, compete with the best future version of edX? Khan? Minerva? The bundlers will begin their slow descent into glorified credentialing services, and then test centers with Gothic halls.

With education debundled, students will no longer undergo a whole four years of education, but present disaggregated credentials for various courses. Tyler Cowen sees the future in, I don’t think, a dissimilar way:

The more likely scenario is that the variance of the return to having a college education has gone up, and indeed that is what you would expect from a world of rising income inequality.  Many people get the degree, yet without learning the skills they need for the modern workplace.  In other words, the world of work is changing faster than the world of what we teach (surprise, surprise).  The lesser trained students end up driving cabs, if they can work a GPS that is.  The lack of skill of those students also raises wage returns for those individuals who a) have the degree, b) are self-taught about the modern workplace, and c) show the personality skills that employers now know to look for.  All of a sudden those individuals face less competition and so their wages rise.  The high returns stem from blending formal education with their intangibles.

Except it’s not the variance that’s important. I see it this way. Every college student’s future earning potential, after controlling for background and genetics, is normally distributed. The uncertainty arises from intangibles (call this the Charles Murray factor) but also dumb luck. As Cowen has it, we would agree that it is the variance of means that increases when, in fact, it is the variance of variances. There’s no way to forecast this, or even form a Bayesian prior on what one’s normal distribution is. But we can assert that it exists, and that it will change.

It’s a little tricky to explain why I think this. An increase in variance, other things equal, means there’s a higher chance that someone with a lower mean (because they came from a poor family and such) will end up in the top decile. That’s clearly not the case. So we can take the inequality of prior means to be a background condition, the symptom of an unequal country. Within this context, the debundling of education will increase the variance by allowing students to more accurately target their strengths. There’s also much more room for falling below the curve without the guidance of an environment. The variance of variances increases because certain people, poor and not, will choose to take a “safer” path, that doesn’t lend itself to mobility.

Net net, you will see that more surprisingly poor kids make it “out” in the debundled world, than the counterfactual of our current education system. And you’ll see more people do even worse. So Cowen is right, in a sense, that the variance of the aggregate normal distribution will increase. However this is predicated on a background trend (inequality) that almost guarantees that result.

Variance across the aggregate normal is bad if it emerges from variance in individual means, and concentration of uncertainty among the bottom quintile. But variance on the individual, to the extent it is equally distributed, is a great thing. Variance kills despondence of the poor. It kills complacence of the rich. Indeed, we should do everything in our hands to make the prior normal distribution of a one year-old, just about as uncertain as possible.

That is the goal of a competitive society. It’s a well-known story that soon after the American Revolution, productivity stateside skyrocketed versus Britain. The absence of a state-protected aristocracy gave the American farmhand huge incentive to work hard, and get rich. His variance was high.

The “Great Unwinding” is better understood as not just a divergence of mean but also a contraction of variance. My certainty that I’ll never be “on the dole” – as an eerily high number of Americans, at one time or another, are – is a sign of societal ill. And the debundling of education can fix that.

A certain group will be exempt. Indeed, I expect that Harvard and Yale will last longer than America itself. The intense agglomeration economies within Ivy League and such schools, and the incredibly different population that attends, is removed from the scope of this observation. But take comfort that the top 25 schools graduate less than 1% of the population. Indeed, once the variance of variances of the population increases, competition to attend the Ivy League will follow suit, and next time around rich kids may not have the upper hand they do today.

Alas I am not predicting an end of inequality. But I do see in the Internet’s evolution a huge potential for more equal opportunity. I fear that too many will still be slave to genetics. Whether of looks, brains, or charm. What’s my most absurd belief? I will die in a Rawlsian society. At age 18, I will also say it is my most optimistic belief.

Kindred Winecoff (via Brad DeLong) has some thoughts on inequality:

1. Global inequality, which was expanding from 1800-1975, and receding since (due primarily to China and India).

2. US inequality, which was declining from 1925-1980, but increasing since, in two ways:

2.a. The separation of the top 20% from the bottom 80%, partially as a function of college wage premium.

2.b. The separation of the top 0.1% from the rest of the top 20%, for reasons unexplained.

3. The rise of the top 1% globally — the development of a new international plutocracy — since… 1980 or so?

For reasons that escape me he does not link the three together. It seems an obvious thing to do. It’s what Oscar Landerretche (the other participant in the discussion) does, in the context of explaining outcomes in Chile. But he doesn’t do it.

This is something that has disappointed me about the conversation regarding American inequality over the past few years more generally. (I’ve written about it before.) Folks like DeLong, Krugman, Cowen, and others think in global terms quite frequently. But when they seek to explain the Great Stagnation and the rise of inequality they concern themselves almost entirely with local explanations. I think such analyses are very likely to suffer from omitted variable bias.

Around the 43rd minute, DeLong takes a direct question about this from the audience. He answers it fairly well, but still downplays the role of the global economy in influencing outcomes in the US, favoring cultural explanations (e.g. explosion of CEO pay) and changes to marginal tax rates. He does not consider that these might be related to global dynamics either. If global forces eroded the bargaining power of American Labor, then maybe that’s why society has tolerated the enormous increase in executive pay. If global forces are pressuring American corporations through new competition, then maybe we’ve cut top-end taxation in an attempt to gain back some competitiveness.

This takes a highly simplistic view of inequality in the world. The reason you can’t just “link” the three together are captured in this one, little chart from Conceição and Ferreira:

The GINI Index is intuitive but ultimately handcuffed in how much it can tell us about the economy. Especially when we’re talking about the world. A far more robust measure is the so-called Theil Index. The math behind the measure (between 0 and 1) requires a fair understanding of information theory but the idea is lower index implies a higher economic “entropy”.

Your physics teacher might tell you that this is a bad thing but, economically, it’s a little more complex. As Boltzmann showed, entropy increases as predictability of an event decreases. This means the entropy of a fair coin is higher than a biased one. Similarly, in a very equal economy it is very difficult to distinguish between two earners based only on their income. Indeed in a perfectly equal society this is impossible. However, as society stratifies itself, knowledge of ones income conveys far more information (redundancy), thereby decreasing entropy.

Within a system, Theil makes it easy for econometricians to understand the amount of total inequality due to within-group inequality and across-group inequality. If this is a little hard to grasp, think about it this way. If the total differences in economic output remained constant between countries (that is, India is still poor and Norway rich) but income was equally distributed within each country the residual inequality would be the “across-country” inequality. The residual from the converse, where all countries remain as unequal as they were, but world economic output is distributed equally to countries (not people), represents the “within-country” inequality.

So what’s my point? While global inequality has been on the decline (because of, as DeLong notes, China and India) the inequality within Asia is about 27% more significant than it was in 1970. This means DeLong’s answer is pretty accurate. While the GINI shows a worrisome increase in American inequality over the past thirty years, its contribution to global inequality hovers around 9%.

There are strictly local factors that can be attributed to increases in American inequality. Sure, global competition puts a downward pressure on American wages but this comes from basic trade and, theory tells us, that this increases output for both parties. This means the American pie is growing (and, clearly, it has) and bad policies are inhibiting the necessary redistribution.

Winecoff also conveniently ignores that the median American worker has become exponentially more productive which would, in normal circumstances, imply higher wages. Alas, local factors have prevented this from happening.

DeLong is very smart in not extrapolating meaningless inferences from his simple observations. If what Winecoff asserts is correct, American worker bargaining power is undermined by a smaller between-country inequality but, relatively, it is the within-country inequality that has grown and, most significantly, in Asia.

American CEOs are earning 300x their median worker is nothing more than the fraying separation between Chief Executive and Chairman resulting in the extraction of severe rents. Lower marginal tax rates on the rent-earning minority have no effect on global competitiveness but explain pretty well the growing importance of within-country inequality.

Edit: Winecoff comments below:

So first of all, trade is not a “strictly local factor”. That’s my point. And what economic theory tells us is NOT that trade is redistributed equally; far from it. Comparatively advantaged sectors/factors benefit from trade, while comparatively disadvantaged sectors/factors suffer. What I’m suggesting is that the American comparative advantage changed post-1970 or so. Previously, it was advantaged in manufacturing, and post-GATT trade liberalization helped it exploit those advantages. Post-1970s or so, the collapse of Bretton Woods capital controls and pursuit of export-oriented industrialization efforts in Asia and elsewhere, the US comparative advantage shifted to finance and other high-capital output (e.g. information tech, pharma, etc.). These require smaller inputs of labor, so the share of national income going to labor declined. Hence: increasing domestic inequality in the US, without a concomitant rise in global inequality (since trade benefits all societies in aggregate).

I’m not denying any of this, in fact I pretty clearly noted above that trade in the last decade or so has accrued in the hands of a relative few. America’s competitive advantage doesn’t benefit the middle man, anymore. But this is not cause to throw our hands up and call it a day, because trade is “global”. There are plenty of things we can do at home. If America’s competitive advantage is exporting math/science know-how, then we can make it a lot easier for people from poorer families to get a STEM degree. If the Ivy League is our competitive advantage, we can take a lesson from this BPEA report and encourage low-income students to apply to top colleges.

In fact, over the past thirty years, as our competitive advantage shifted, we did precisely the opposite of what we ought to have done. It is hard to fight against a falling wage share of GDP. In fact, economically, this is probably a good thing. However, we should have fought hard against the growing inequality within wages themselves.

A side note: I have not “conveniently ignored” the fact that median productivity has increased exponentially. That is not an established fact. As far as I know there is no evidence that it has. Productivity statistics like those issued by the BLS are calculated on a per-worker (i.e. mean, not median) basis. Mean compensation has tracked productivity fairly well. It’s the median that stagnated, which is one definition of rising inequality: a separation of the mean from the median.

I don’t buy this. While the BLS statistics are average productivity the way to explain Winecoff’s argument would be that only the top 1-5% of American workers got better at their jobs. The median worker, with better capital, has gotten a lot more productive. The last 40 years also brought many women into the workforce. With a 100% increase in productive workers for most households, one would not expect such a stagnant increase in overall income.