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The common tale of inequality in modern America starts in the 1970s. The disintegration of labor unions, foreign competition, or any melange of factors exert a downward pressure on working-class wages. But in the standard narrative, the last quarter of the 20th century is a good time for women. Rapid female entry into the labor force meant less of Peggy the Secretary and more of Peggy the Copy Chief. Graphs like this certainly corroborate that story:

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But that’s only part of the whole picture. The dynamics of inequality within male and female decompositions tell another story. Rather than use the standard Gini as a measure, I’ve created a time-series (from BLS data) with the ratio of the difference between mean and median incomes to the total mean income (call it mean-median, or MM, inequality). This captures “inequality” pretty well. Think about a bar with ten average guys, all earning between $40,000 and $60,000. Let’s say the mean and median are $50,000. Now imagine Steve Jobs enters the room. The median earnings would barely increase, but the mean would skyrocket beyond belief.

That is, the mean is sensitive to large outliers – and we’ve had more of those in America, lately. Take a look:

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This gives another context to the first graph. The position of the median female has increased relative to male salaries not necessarily because of more education and entry into the labor force, but the decline of the median man relative to the mean man. (Actually, there is no such thing as the “mean” man, but you get my point).

In the 1960s, the median income was more than 95% of the mean income. Today, it’s a bit less than 70% for males and females. Eyeballing the graph (not a statistically rigorous exercise, I know) there seems to have been a rapid jump in the secular ascent of male inequality around 1994: curiously the year NAFTA came into effect. It’s harder to draw conclusions about female income dynamics. But here’s an interesting correlation:

diffineq

Correlation is not causation, but data seems to suggest that the improved position of female workers today derives in large part from increasing mean-median inequality within male workers. Note that over the time period considered, female inequality shows only a bare increase and the difference rises almost entirely from increasing male inequality. At this point, some of you might be wondering whether my “definition” of inequality is appropriate to begin with. Gini is more statistically sophisticated, and Theil better still. So I checked historical Gini coefficients against what I call an “I-factor”, where

i = (male share of labor force)*(MM-inequality for men) + (female share of labor force)*(MM-inequality for women)

Unsurprisingly, i correlates pretty decently with Gini:

ifactor

Clearly it’s a good fit, so we have good reason to expect that MM inequality represents a decent idea of male and female income discrepancies, at least to the extent that Gini is a sufficient measure. I’ve inserted a linear trendline, though it does seem either some form of an s-curve would be more accurate or there’s a cut at i > 0.20.

There are no big conclusions here. Just some easy, spreadsheet regressions. But it suggests the standard story of inequality deserves another examination. Has the position of the median female worker increased any? As Larry Summers likes to say (in relation to the vaunted debt-to-annual-GDP measure) ratios have the unfortunate habit of needing a denominator. In the female-male income ratio, the emphasis has been too focused on the rise of the numerator, that the deep relative stagnation of the latter is forgotten.

Indeed, a remarkable chunk of the ratio can be explained by increase in male MM-inequality. As a group, females fare a lot better today than during Don Draper’s age. But the inequality within hasn’t fallen, and is only recently comparable to that of men. Yet, despite any of the million factors we believe increased overall inequality, female income discrepancies have at least resisted any upward trend.

But, if nothing else, we’re finally living in a world where inequality is spread equally.

Update: Brad DeLong here notes that there’s a bit of a straw man argument that liberals don’t care about the skills-based gap. To the extent that I am a liberal, I definitely think he is right 😉 

Timothy Noah has a new post at the New York Times arguing that the 1 percent are only half the problem. Of course, my first reaction is that their share of the problem is even more disproportionately allocated than their share of the income! Snark aside, I’m not sure organized labor is the solution to America’s “skills-based gap”. Here’s Noah:

The decline of labor unions is […] important. At one time union membership was highly effective at reducing or eliminating the wage gap between college and high school graduates. That’s much less true today. Only about 7 percent of the private-sector labor force is covered by union contracts, about the same proportion as before the New Deal. Six decades ago it was nearly 40 percent.

The decline of labor unions is what connects the skills-based gap to the 1 percent-based gap. Although conservatives often insist that the 1 percent’s richesse doesn’t come out of the pockets of the 99 percent, that assertion ignores the fact that labor’s share of gross domestic product is shrinking while capital’s share is growing. Since 1979, except for a brief period during the tech boom of the late 1990s, labor’s share of corporate income has fallen. Pension funds have blurred somewhat the venerable distinction between capital and labor. But that’s easy to exaggerate, since only about one-sixth of all households own stocks whose value exceeds $7,000. According to the left-leaning Economic Policy Institute, the G.D.P. shift from labor to capital explains fully one-third of the 1 percent’s run-up in its share of national income. It couldn’t have happened if private-sector unionism had remained strong.

Now, for the record, I think strong and healthy union membership is a good, countervailing force to the power imbalance between employer and employee (particularly in scaled, factory environments). However, it’s not the answer to our economic woes. I’m a left-leaning liberal: but a lot of this sounds more like high rhetoric than a realistic assessment of history. See the emphasized, why on earth should the wage gap between college students and high school grads be smaller

As technology advances, and capital becomes an efficient replacement for labor, we would expect – unions or not – college graduates to earn more. As America develops, adjusts to a globalized world, and realizes its competitive advantage in “knowledge” products, are we really surprised that the relative wages of a programmer is growing faster than those of a bus driver? And – as left-leaning liberals – have not those of Noah’s ilk been calling for more education this whole time? Isn’t Noah blowing away the strongest argument for government-subsidized education, especially of the poor? And without education, where on earth will the poor we care so much about find social mobility?

Most importantly, why do we think this is a bad thing, the idea that college pays? Noah squarely places a good part of the blame on the financiers and corporate executives in the 1%, but he doesn’t go far enough. When he talks about America’s “mass affluent” and the growing gap between the top 10% and middle 20% he ignores a few things:

  • The lions share of income in the top 10% (his baseline is incomes $100k or so and up) goes to its top 1%.
  • By targeting the broadly educated elite, the burden of taxation is shifted from rent-earning executives to scientists, engineers, programmers, as well as  main street lawyers and bankers. We actually want more of these people, and there’s pretty good reason to believe STEMers are woefully underpaid.
  • I’d much rather the college premium be higher and more people graduate, especially if it means fairer wages for engineers.

Further, from a distributive standpoint, incomes allocated to the 1% are significantly more important than anyone else. I would much rather the marginal tax dollar be derived from a rent-seeking executive than a run-of-the-mill college graduate. This is a false dichotomy, but helps underscore my disagreement with Noah. A mass labor movement with the simplistic goal of narrowing the college grad/non grad gap is sure to bring the former down rather than the latter up. A mass labor movement, without any aid from strong, protectionist government policy, will result in greater unemployment. At a time when companies are finally reshoring operations, it would be wrong to petrify America’s labor market. 

Of course, the United States could implement strong industrial policy with full employment as a key goal, but not without dismantling the free trade system we built. After Bretton Woods, a good part of American foreign policy was creating an international system (indeed led by the United States) conducive to free trade. 

I’m not really a proponent of the right-to-work laws that are plaguing this country, either. After all, nothing seems more coercive than the government forcing firms to provide non-union contracts. But as we move towards a far more “knowledge-based” economy, for wont of a better term, I really don’t see union-building as a way to edge inequality.

From a social perspective, the lives of the mass affluent are far closer to the middle-class than the 1%. Sure, they might have more books at home, more savings, a higher priority on education, but the qualitative differences rise at much higher incomes. Mansions on Long Beach should be of more concern.

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:

ImageThe 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.

Evan Soltas has a very interesting blog post about intergenerational inequality. The thrust of his argument is that inequality in educational attainment exists, even adjusting for differences in income. At some level, this is trivial – one would expect educated parents, wealthy or not, to spend more on academic pursuits for their children. The conclusion Evan draws, however, is quite fantastic that is, the effect of educating a kid today is geometrically valuable:

Here’s why that math is important. The high school dropout rate among people whose fathers were dropouts is 22.2 percent. The dropout rate with high-school-grad fathers is 2.9 percent. Let’s assume that the social value of a high school degree is $30,000 per graduate; that’s roughly the difference in average income between non-grads and grads. Public policy that supposes they are helping one person assesses the value of that degree at $30,000, obviously. Public policy that supposes they are helping an infinite succession of people assesses the value of that degree at $819,000.

He arrives at a whopping $819,000 as the difference in the net present value of fathers with and without high-school degrees in terms of the future earning potential of their kids. I would argue that the value of a high-school degree is somewhat less than $30,000 because a good amount of the delta is derived from the further division between college graduates and non-graduates. This wouldn’t change the situation if the deviation was randomly distributed (and college actually added value, a contestable claim), but there’s good reason to believe it’s not. (For example, there are definitely demographics in which it’s very likely a child graduates high school, but also very unlikely that he or she graduates a 4-year college).

That even basic jobs require a college degree nowadays would further diminish the value of a high school degree by itself. The $819,000 figure includes the increased chance of attending college, which is far more dubious in its actual value added. A more conservative, but not necessarily better, approach would be to estimate the value added by high school itself, assuming that college adds no value, or approximately $11,000, according to Pearson.

The geometric multiplier is about 26.15, yielding a present value of $298,615. This isn’t nearly as astonishing as Evan’s $819,000, and probably isn’t as close to the truth. However, it does compound an already compelling case for investing in high school education; that it’s worth it even if no one ends up at college. At a public school, the average cost per pupil is $10,652 or about $40,000 for a degree, or a 645% return on investment. This is a low-hanging fruit.

I think there’s one big flaw in the way Evan looks at things; it’s also important to note that the value of a high school education is hugely understated by the calculated figure, because it is the difference in annual income. The effect over a lifetime is many multiples of this. For this reason, the return on a high school degree, a net of 645%, doesn’t begin to approximate the real value of an education.

A final caveat, I have a pretty strong feeling that education by itself doesn’t explain the intergenerational inequality in education. As it happens, I came across this passage in a recent copy of the Economist:

The well-to-do [have] largely held to old-fashioned ideas about marriage. Among professionals, births within marriage are four times as common as births where the father is registered as absent from the household.

This is for Britain, but the gap is only worse in America. The figure below charts educational attainment of a child by family situation at age sixteen.

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One can see an almost twofold increase in dropout rate between dual and single guardian households (the exception being families where neither of the guardian is directly related to the child). The geometric multiplier between a nuclear family and anything but is about 20. While this is less than that of a high school degree, the policy cost is also substantially less than $40,000.

Today, in many ways, we disincentivize marriage – as Nicholas Kristoff grimly notes – with poorly designed welfare programs (such as handouts to single mothers). As the Economist notes, I don’t believe the chain of causality is as strong between an educated parent inculcating similar values in his children as much as strong tendencies towards the nuclear family among the educated, which themselves engender stronger attitudes about education.

Regardless, any of these points are a damning indictment of the “American dream”. Policymakers need to acknowledge the importance of a high school education. We’ve spent billions in grants and subsidized student loans for college that implicitly benefit the lucky, that is those who already have a high-school education.

Further, it is far from established that college today adds economic value to society. The huge underemployment of recent graduates (which itself causes the unemployment of those without a college degree) should make each of us think twice while promoting the virtues of college.

Indeed, the advent of online courses further convinces me that college is but a licensing factory. For example, a University of Washington course in Financial Econometrics is provided on the Coursera platform, with the additional option of doing slightly more work and receiving slightly more attention, at a price tag of $4,000. This is absurd. The only value derived from the for-credit option is Washington’s official stamp of approval, a license.

By blindly subsidizing college education we’re implicitly encouraging rent-seeking behaviors that are damaging to society as a whole, especially those at the bottom. Evan’s point is clear: we need to stop acting like a high school degree is its present value, so long as inequality persists. Indeed, Evan hugely underestimates the value of his own claim by ignoring the lifetime effect of increased cash flow. For those of you interested in that figure, even discounting at 15%, it’s over $10 million.

Noah Smith has an article in The Atlantic about wealth inequality in the United States. A viral video caught the attention of the economics-blogosphere, and Noah is the latest to comment.  The import of Noah’s argument is the importance of thrift:

Today, wealth equality is closely tied to income equality. But in the long run, it’s all about thrift, frugality, and saving — in other words, teaching a consumer nation a lesson in cheapness.

Progressives have a hard time ascribing wealth inequality to savings rate and (predictably, though not incorrectly) blame structural issues like falling wage share of income. As one very popular commentator notes:

This is absurd. The real wealth gap is based in capital gains, not direct income. Teaching Americans to be frugal is not going to address any of the systemic differences that make it easier by orders of magnitude for the already rich to keep making money.

The fact is, poor American’s can save, they just have really bad habits. For example, as Derek Thompson notes, the poor spend a whopping 9% of their income on lottery tickets. So let’s be honest here, the whole diatribe against Noah that the poor can’t save is crap.

If we’re going to talk about wealth inequality, it’s pretty informative to understand its emergence, why it’s fundamentally different from income inequality, and why an “equal” society won’t help. Consider, an island which is functionally equal – you might say socialist. I’m not suggesting this is a plausibly sustainable situation, but it’s an interesting starting point. Let’s also assume that somehow socialism hasn’t eroded work ethic and desire to innovate. In reality, this isn’t a reasonable assumption, but I’m not making an argument about economic ideology.

So, on day one, the Keynesian economist, farmer, laborer, and lawyer each earn $100 a year. The economist is a spendthrift, with a good taste for Portuguese wine and Victorian clothes, and has only $10 left each year. The laborer, saves diligently, and has $50 leftover. Very soon, an island that once had income equality becomes very unequal, both in income and wealth. The wealth inequality comes first, but soon the laborer has more money to invest in his daughter’s education, and to loan to the moderately-thrifty lawyer and farmer to earn a good return.

So wealth inequality comes first. This is especially true if you consider, in our society, income derived from education to be a capital gain (though, legally, it is treated as labor). In the island, wealth and income inequality were both functions of preference.

However, in our society, as wealth inequality isn’t just a function of preferences, but income itself (in the island this isn’t the case because future income inequality is derived from wealth inequality which itself is derived from preferences). But, in a given snapshot, wealth inequality grows as, in some ways, the integral, roughly speaking, of income inequality.

This is because, if preferences are randomly distributed, the savings become a function of income. As income inequality rises (as it has in the past 40 years), the ability to save gets rather more concentrated amongst the rich. This, and not preferences, becomes the key force of wealth inequality. This is further compounded by the fact that, in a very literal sense, wealth begets wealth through capital income.

So my point of all this is I think Noah’s wrong that somehow altering preferences will fix the situation. Noah argues that, for a “return to equality”, the poor need to be nudged and educated:

In addition to “nudging” middle-class and poor Americans to save more, we can help them get a better return on their assets — the second thing that has a huge effect on wealth in the long run. This means helping middle-class people invest in stocks without paying high fees. The first part of this is teaching middle-class people to avoid making frequent changes in their stock portfolios. Studies show that individual investors consistently lose money when they try to buy and sell and buy and sell, mostly because they tend to ignore trading costs. So financial education should teach people to let their stock portfolios just sit there for decades, and ignore the ups and downs.

The second way to get better returns is to avoid actively managed funds. Actively managed mutual funds charge high fees to purchase portfolios of stocks that, statistically, are no better than simply buying a low-cost “index” fund that tracks the overall level of the market. Pension plans like TIAA-CREF tend to charge even higher fees, meaning even worse returns. Financial education can teach middle-class people what a low-cost index fund is, and how to invest in one.

The first point is rather interesting, and Richard Thaler has the best evidence that it might work (Save More Tomorrow – fantastic study, I think everyone should read it). I don’t have much to say about personal finance education, I think it’s important, but I just don’t think it will have a lasting effect on habits in a consumer culture. Education will be artificial and instituted in the context of grades, which will be the only reason people pursue the subject.

But, as I argued, changing preferences will have only an ephemeral effect. What we need are:

  • Robust risk sharing programs (particularly universal healthcare, strong social insurance, and unemployment insurance). This will a) decrease the need for wealth, mitigating the effect of wealth inequality and b) allow the poor to invest most of their income in stocks, so that they can take part in America’s wonderful capital market. Noah mentions China a country that’s poor but manages to save a lot. One of the many reasons for this, I believe, is an underdeveloped insurance market, creating a greater need for wealth.
  • Ban lotteries. This is simple. Sure, states make a lot of money from them, but this is absolutely the most regressive tax in the country. Not only are educated people informed enough to know that the state has an edge, but it’s a very small part of their income.
  • “Nudge” Americans to save through opt-out programs sponsored by an employer.
  • Institute a progressive consumption tax with negative income
  • Fix income inequality.

The integral-relation with income inequality explains why it will always grow as income inequality is constant, but wealth distribution doesn’t need to be as skewed as it is. Preferences will go some way, but the real change needs to come from income distribution (by investing in human capital) and access to capital markets (by pooling risk).

The falling role of labor in our economy will make wealth very important. Acting now is a pretty good idea. But, moving on, let’s remember a few things: demand creates supply, and wealth inequality creates income inequality. Let’s not mistake cause and symptom.

@DavidA on Twitter points us to an old post by Joe Seydl arguing that economists are no longer allowed to speak about normative social problems, like inequality or climate change:

I propose a new rule: economists are no longer allowed to speak about normative social problems, such as rising inequality or climate change. Let’s leave the discussion of such problems to the philosophers.

The justification for this rule comes from the fact that solutions to normative social problems require selfless thinking. And there is ample evidence to suggest that economists behave in more self-interested ways than do noneconomists.[1]

Consider rising inequality. The philosophical justification for rising inequality can be found in John Rawls’ philosophy. In “A Theory of Justice,” Rawls argues that it is just to increase inequality up to the point where any further increase would leave the position of the least-well-off member of society unchanged. In other words, any increase in inequality that is worth bearing, according to Rawls, must benefit the worst-off members of society in some discernible way. This is known as Rawls’ Difference Principle.

A starting point for Rawls’ Difference Principle, however, requires that one at least has concern for the least-well-off members of society. Economists clearly don’t meet this criterion, because the distribution of efficiency gains rarely matters to them; why else would the majority of economists support a whole host of free-trade agreements that put manufacturing workers in direction competition with workers overseas, while at the same time protecting highly paid professionals, such as doctors and lawyers, from the same competition? The answer, of course, is that economists do not care about the well-being of manufacturing workers.

[…] Or consider climate change. It is all well and good if resources are allocated in such a way that leads to high productivity growth and rising living standards in the near term, but what about the longer term? Efficiency gains are “worth it,” according to the philosophers, if the gains are sustainable; and, importantly, if the gains are sustainable over many generations. If rising living standards over the next few decades come at the expense of more frequent droughts, floods, and devastating heat waves for future generations, then the near-term gains are probably not be worth pursuing.

Economists are incapable of thinking about sustainable development, because sustainable development requires a concern for the well-being of future generations. The rational-choice model that dominates neoclassical economics assumes that individuals are always in pursuit of their own material self-interests, saying nothing about the interests of future generations.

The rational-choice model may or may not be an accurate description of human behavior; there is evidence to suggest that humans often act irrationally, especially when it comes to their evaluation of sunk costs or charitable givings.[2] But it doesn’t matter, because so long as exposure to the rational-choice model increases the likelihood of selfish behavior, the implication is that economists will be in an increasingly poor position to evaluate normative social problems.

Economics wasn’t always this way. For example, in the 1940s, 1950s, and 1960s, Paul Samuelson wrote a great deal about the mixed-economy model, which stressed the importance of development on three fronts: efficiency, fairness, and sustainability.[3] (The latter two requiring selfless thinking.) But it’s unlikely that the profession will ever adopt a more outward stance on human behavior, as the standard rational-choice model can be thought of as a relentless force that only grows stronger with time.

For this reason, it makes sense to limit what economists are allowed to speak about, rather than sit around wondering whether economists will one day incorporate selflessness into their behavior models. If economists would like to speak about profit maximization in a particular market or how economies of scale differ across markets, then fine. But, please, let’s leave the normative questions to the philosophers.

Anyone who’s fully content with the way modern economics works needs to wake up. Even pretty ardent supporters of the EMH (like Larry Summers or Alan Greenspan) accept this. The recent financial crisis gives full life to this concern. However, the concern voiced in this quote is misguided in theory, and can be dangerous in practice.

Consider the Rawls’ Difference Principle. Without economic reasoning and analysis, how exactly is one supposed to figure out “the point where any further increase [in inequality] would leave the position of the least-well-off member of society unchanged” ? More importantly, what way to philosophers have to determine the “right” philosophy (at least economists are getting to the point where their convictions are either justified or falsified by data).

A radical philosopher (I’m thinking his name starts with an ‘M’ and ends with an ‘X’) might suggest that any level of concentrated capital ownership breaches this principle. In ideality, we would have an equally poor society, and in reality we would get Josef Stalin. Full disclosure, I think Marx was a terrible economist, but a pretty fantastic sociologist, ahead of his time.

This post also ignores that there are plenty of philosophers who are okay with an entirely self-interested society. Conversely, many economists are in favor of a kind and caring society. Indeed, the father of classical economics, Adam Smith, was himself believed that charity and trust ought to underpin any capitalistic society. Note the normative claim.

On the other hand, we have philosophers like Ayn Rand who believed love and marriage were for idiots, and atheistic selfishness was the way of the future.

The idea that economists can’t handle climate change is equally dubious. Indeed, I think global warming can be solved, entirely, in the hands of modified neoclassical thinking. The problem with simple economic models is the consideration of oil, gas, and coal as cash flow rather than capital stock while treating a sustainable environment as a public good rather than eroding resource. This is an idea embraced by E.F. Schumacher in Small is Beautiful. Though, unlike me, he prefers a Gandhian-agrarian society to capitalism. It was also this idea that compelled one of history’s most brilliant men, Buckminster Fuller, to suggest that the natural cost of oil is over a million dollars per barrel.

Within neoclassical models, were these assumptions of measure to be changed, we would very quickly move towards rapid carbon taxation and renewable energy. Further, it requires science and calculation to solve this problem, not the normative whims of an armchair philosopher. Indeed, it is the social philosopher within the economist that averts a wider cry for high carbon taxes.

Even conservative mainstream of economists, like Professor Mankiw, believe in an economic solution to our environmental problem. However, it is the the knowledge that a rapid decarbonization will corrode our society and political institutions that prevents a move towards this tax. 

If we’re going to talk about mistakes economists have made why not John Locke’s idiotic defense of slavery. Indeed, it’s quite a bit easier to contrive philosophy towards a defense of slavery than it is any form of economics, which would argue that the abridgment of individual agency in commerce would broke a society. An economist’s argument; but a right argument.

The rational-choice model is widely criticized, at least in its simplistic form, even within the economics community. Not because it doesn’t yield the fair outcome, but because in our modern society it makes inane assumptions (no, I don’t consider my potential income in the year 2050 and raising interest rates against my utility function for a given tomato in making my purchase). That doesn’t mean the economics mindset is wrong, it means it has to change.

This post further assumes all economists would fall under the narrow realm of ‘mainstream’ economists. Plenty, have argued for a more equal society. What makes a philosopher more suited to judge “what is just”. Or, a more potent question, what makes a philosopher?