Category Archives: economics

does income inequality really matter?

If you spend much time following the news these days–and especially the 2008 presidential campaign–you will have noticed the ebb of a backlash against income inequality. Data are showing that economic gains are largely accruing to only those at the top of the income distribution. (There are all sorts of good papers on income inequality. For the best, I’d recommend Dew-Becker; Yellen; and Pikkety/Saez).

A good number of left-leaning Americans are pallid with fear about this trend. To them it represents a break-down of our social contract and a failure to meet our obligations to the worse off. But do we actually have reason to care about inequality in and of itself? Harry Frankfurt, a professor of philosopy emeritus at Princeton, makes the argument that it’s not inequality that matters but how much the poor actually have. Similarly, Mickey Kaus argues that it’s not money inequality that matters but rather the shift in social mores that, at present, dictate that individuals with more income are higher on the social ladder; that they’re more important (he also makes the Frankfurt argument). In its shortest form, it’s not income inequality that matters but what income inequality represents: a material lack of the worse off or undesirable social values.

Others, such as Robert Frank and Erzo Luttmer, argue that inequalities–differences in relative well-being–have a measurable impact on happiness, as individuals report it in survey data. If income inequality actually makes people less happy then we should care about inequality in and of itself.

A new paper from Karen Dynan, of the Fed, and Enrichetta Ravina, of NYU, shows that although inequalities do negatively impact happiness they only do so above a certain threshold. They write:

The implication is that the happiness of people in groups with below-average earnings is little affected by how much their earnings differe from the average, while the happiness of people in groups with above-average earnings is considerably affected by how much their earnings outperform the average.

If you care about income inequality because of sentiments for the worse-off members of society (who really cares if a millionaire is less happy than a billionaire due to the disparities in their earnings?) then there seems to be little reason for caring about income inequality in and of itself. The arguments made by Frankfurt and Kaus are, in my opinion, still the most compelling when it comes to how we should think about inequality.

Citation for Dynan/Ravina paper: 

Dynan, Karen and Enrichetta Ravina, “Increasing Income Inequality, External Habits, and Self-Reported Happiness,” American Economic Review, Vol. 97, No. 2, May

2007.

the end of equality

From The End of Equality by Mickey Kaus:

Something unpleasant has happened in America in recent decades. It’s not that the country has gotten poorer. It hasn’t. It’s not that the poor are poorer now than they were, say, when I was growing up in the 1960s. They aren’t. But the significance of money, the role of money has changed in ways that conflict with most Americans’ image of their country.

We’ve always had rich and poor. But money is increasingly something that enables the rich, and even the merely prosperous, to live a life apart from the poor. And the rich and semi-rich increasingly seem to want to live a life apart, in part because they are increasingly terrified of the poor, in part because they increasingly seem to feel that they deserve such a life, that they are in some sense superior to those with less. An especially precious type of equality–equality not of money but in the way we treat each other and live our lives–seems to be disappearing.

 

gender differences and educational attainment

Susan Dynarski, of the Kennedy School and NBER, released a new paper in May titled, “Cradle to College: The Puzzle of Gender Differences in Educational Outcomes.” She has some fascinating findings that I think are worth highlighting.

  • Women account for nearly all of the recent growth in the education levels of the labor force.
  • Between 1979 and 2005, the percentage of of 29-year-olds with a B.A. rose from 23 percent to 32 percent. Men contributed one percentage point to the increase while women contributed the other eight.

In general, Dynarski provides data that suggests that women are much more responsive to changes in the cost of college. Dynarski writes, “a drastic reduction in the cost of college substantially increases the college enrollment and completion rates of women, but has no impact upon men.” She concludes that a policies which make college cheaper will increase enrollment but will also widen the gender gap.

For those interested in expanding Pell Grants, is this an acceptable trade-off?

the persistence of poverty

Below is a summary of a new book out called The Persistence of Poverty by Charles Karelis. It’s an interesting read and I’d certainly recommend it. Even if you don’t buy the arguments he presents a novel way of thinking about the issue of ‘irrational’ behavior amongst the poor.

Views about the behavior of the poor traditionally fall into two camps: dysfunctionalism and non-dysfunctionalism. The former holds that the poor engage in poverty-worsening behavior as a result of psychological dysfunctions such as pathological apathy, a fragmented self, or a weak will. Non-dysfunctionalists believe, by contrast, that the poor remain poor not because of dysfunction but because of unduly limited opportunities or perhaps perverse incentives created by public policy.

 

Conventional economics argues that the poverty-worsening behavior exhibited by the poor (e.g., non-work, non-education, crime, alcohol abuse, non-savings) are irrational because of marginalism; the poor ought to exhibit ‘good’ behavior since the marginal benefit of, say, income or education is greater than it is for the non-poor. But Charles Karelis argues that the poverty-worsening behavior is actually rational behavior for the poor, although it is irrational for the non-poor. He claims that the poor face increasing marginal utility below levels of basic needs rather than decreasing marginal utility from the outset.

 

Karelis postulates that there are three different types of goods: relievers, pleasers, and goods that function as relievers at low levels of consumption and pleasers at high levels. Pleaser goods, such as a glass of fine wine or a rich dessert, always exhibit diminishing marginal utility. But reliever goods, such as basic food needs or salve for a bee sting, exhibit increasing marginal utility. Imagine that you’ve been stung six times by a bee. The salve that you put on the first sting won’t make as much of an impact as the salve that soothes the very last sting. Likewise, quieting a shout in an otherwise silent room will make a much greater impact than quieting a shout in a riot. Karelis argues that this is true for all goods that function as relievers.

 

When we ask, then, why the poor don’t work (the argument can be applied to other poverty-lessening behaviors), we see that their increasing marginal utility curves suggest that they have little to gain from working initially and the marginal income that they will receive. They will require larger incentives in order to jump into the work force. The poor don’t refrain from work because they are irrational, but rather because they are rational but face increasing marginal utility functions for all goods that can serve as relievers.

 

This, naturally, has strong implications for anti-poverty policy. Karelis, for example, thinks that conventional economics lead us to underestimate the positive effects of wage-supplements, such as the EITC, on incentives to work. If marginal utility of income rises amid true scarcity then supplementing income will encourage workers to work more. He diverges from the mainstream view on the positive effects of toughening welfare by arguing that those who cannot benefit from the EITC, those who are not in the formal labor force, will not be encouraged to work through “tough love” policies. Rather, it’s just the opposite. By providing no-strings assistance we increase the marginal utility of income and therefore make it more likely that they will work. Now, no-strings assistance is obviously politically unfeasible. But we should bear in mind the general point that poverty itself will not be a motivator to join the work force since marginal utility slopes upwards for the poor.

In conclusion, Karelis touches on issues of economic justice, of which there are two widely-held theories: the first claiming that people are entitled to whatever they produce or trade for and the second stating that an allocation is just only when it is proportional to an individual’s needs. Utilitarianism says that we should strike a balance between these two poles by finding out which system of redistribution maximizes total welfare. Karelis’ hypothesis regarding increasing marginal utility suggests two deviations from this utilitarian approach. In the first, according to traditional utilitarianism the moderately poor should give to the worst-off as that would maximize total welfare. Karelis argues that since both are under the threshold of basic needs, the worse-off won’t gain more. In fact, the opposite is true: the better-off poor would lose more than the worse-off would gain by giving it away under an increasing marginal utility curve. Second, utilitarianism suggests that redistribution will decrease the work incentives for both the rich and the poor—the rich because of smaller returns on their work due to taxation and the poor because they can get by without having to work. Karelis’ hypothesis suggests that redistribution will increase the work incentives for the poor. He concludes that this suggests that, at least in the U.S., we should favor a theory of economic justice that favors the second theory of justice, need-justice, more than is conventionally appreciated.

cap-and-trade or carbon tax

Human activity is unequivocally responsible for the warming of the planet. Over the last century, the average temperature has gone up by 1 degree Fahrenheit. Although this might not sound like much, it is half the average increase from the end of the last ice age up until the beginning of the 20th century. Sea levels have risen and will continue to do so. Ecological habitats are strained and unable to adapt quick enough to the temperature. Agricultural systems are becoming more and more strained. In short, we need a solution.

The two most common policy proposals circulating are a carbon tax and a cap-and-trade system. A carbon tax simply levies a tax on carbon output. Different taxes measure carbon emissions in different ways, but the tax generally works by charging per ton or per kilogram of carbon output.

A cap-and-trade system allows firms to trade carbon emissions allowances on the market. The government sets an overall emissions ceiling for the entire economy, prints the equivalent amount of emissions allowances, and then lets firms buy and sell them. A lower-emitting firm can sell its allowances to a higher emitting firm. The amount emitted is still at the set level, but the distribution is based upon needs and determined through the market. The U.S. successfully adopted a cap-and-trade system to limit the emissions responsible for acid rain in the 1990s.

As said previously, a cap-and-trade system sets a ceiling for emissions but there will never be any incentive for firms to emit, in sum, less than the ceiling. Imagine firm A emits less than their share and sells their emissions passes to firm B who emits more. This system is efficient since there is no cash left on the table, as it were; no firm could make any more money by selling emissions permits and no firm could emit more. But imagine that the sum of firms emit less than the ceiling. This will mean that there is cash on the table; there are emissions permits with economic value that are going unused. On the assumption that firms would economically prefer to emit than not, it will be to a firms advantage to emit more until equilibrium is reached at the ceiling. This is traditional supply-and-demand reasoning. Any total emissions point below the ceiling which is the government-set equilibrium point will be economically inefficient.

Now consider a carbon tax system. The government can set a tax rate for which firms will want to lower their emissions until the benefits and costs of emitting and paying the tax are roughly equal. This will be different for different firms. The government can perform market research to find the market equilibrium for a carbon tax and set the rate so that the emissions level will be sufficiently low.

In effect, the level of emissions can be capped just the same through a cap-and-trade system as with a carbon tax system.

less food, mo’ money?

In response to shrinking consumers of quick sit-down American food, T.G.I Friday’s decided to downsize its portions in order to increase profits. It worked. Not only did the compancy, presumably, cut costs but they managed to lure a 1.4 percent increase in customers over a period when the industry decrease was 2.8 percent.

agricultural subsidies and farmers in west africa

According to an article in the New York Times, a drastic cut back of U.S. agricultural subsidies will lead to higher revenues for cotton growers in West Africa. The reasoning behind this assumes that subsidization of the American cotton market is an unfair pampering of an industry that would otherwise be unsuccessful in a competitive market, whereas environmental conditions in West Africa would make it the most competitive cotton-growing market. When a crop is subsidized it, in effect, lowers the cost to farmers for growing that crop, enabling them to produce more for the same price. According to the basic principles of supply and demand, when there’s more of a good on the market (increased supply) the price of that good falls. When the price of the good falls, Oxfam argues, that has serious impacts on the standard of living of poor farmers in West Africa whose governments can’t afford to subsidize them. Eliminating these trade distorting subsidies would have net positive effects.

Cotton is a simple-ish case because there are very few consumers of it in West Africa (lower prices benefit consumers even though they hurt growers). Corn, which is also a heavily subsidized U.S. agriculture staple, is a trickier case because although rural Mexican farmers lose out from depressed corn prices, the urban poor benefit by being able to get food cheaper.

In the NY Times article, Dani Rodrik argues that the changes for the West African farmers will be small and imperceptible. He thinks that the most impact will be made by developing nascent industries that can subsume more families and generate sustainably higher wages. He is quite right that the most durable change will not come from liberalizing trade. But that’s no reason not to cut these unfair subsidies if it can make even the slightest difference for those caught in the cotton fields.