March 14, 2013

Let Them Save Cake

Blogger Noah Smith has an article on wealth inequality up in The Atlantic's business section. The article uses the excellent recent viral YouTube video on wealth inequality in the US as a starting point to make a number of observations and recommendations. Smith has a wealth of fascinating posts on his site and a much better understanding of most things economic than I do, so the article caught me by surprise.

Leading off with an unflattering photo of overweight Americans eating dinner in a house crammed with artifacts of their presumed overconsumption, the article goes on to argue that (1) wealth inequality isn't quite as bad as it appears in the video, (2) redistribution of income could help make the wealth gap better because poor people would save more and take more risks that would benefit them, and (3) income distribution is not enough and we need to teach poor people how to save more effectively.

Strictly speaking, these ideas are well-founded in theory and evidence and I agree with them. But nonetheless the analysis ends up in a very wrong-headed place for several reasons.

First of all, I really think the article is missing the point about the massive concentration of wealth at the top. Maybe saving more would help, but how much? How much of a dent in the inequality graph would it make if the lower quintiles starting saving their entire incomes, for example? Would we get back to where we thought we were? Or where we would like to be?

Second, helping people save might theoretically increase their wealth, but it's a zero-sum game with their current consumption. Weighing welfare effects between present consumption and future consumption is ambiguous here because it is extremely subjective, so I suppose it makes sense to stigmatize one of the alternatives (yuck! those people are fat!).

Instead, shouldn't we understand the problem as being too little income in the lower quintiles first, and understand the lack of savings as an effect of that unequal income? The consumers would save more if they had more money to save. Obviously there are countries with far lower incomes with far higher savings rates, but there is a good argument to be made that relative incomes are what matter. Or at least that expectations about living standards is what matters, which brings us to the next point.

Third, the article ignores the idea that credit has been extended and saving decreased amid working and middle class Americans precisely because of the stagnation in real wages. Whether or not you see this as a deliberate political strategy as Rajan does (along with others more toward the left), the availability of consumer credit has increased in dramatic, important ways (housing loans, education loans, credit cards) since income inequality started rising in the 1980s. And this has kept a lot of people happy. Or fed. The availability of credit has also been a primary driver of demand, without which our economy would be at a far greater standstill today.

There are certainly improvements to be made in wealth inequality through better financial literacy. But ignoring the political economic context for the drastic rise in credit, and moreover ignoring the importance that credit plays in demand, seems problematic--if not vindictive.

Most frustrating, however, is the article's blithe passivity toward the workings of the market. There is no mention in the article regarding what seems to be the fundamental problem: an income distribution that is almost as revolting as the distribution of wealth. Maybe this distribution is simply the innocent working of a "natural" capitalist economy and we are powerless to make it better, but probably not. Probably there are plenty of good reasons why the wage gap has grown in recent years. Many of those reasons we can do something about; ignoring them just helps those at the top keep raking it in.


  1. By extending the thought experiment to the extreme case, in which poor people save their entire income, you clearly demonstrate the absurdity of the argument that inequality can be overcome through savings. I think the other side of Smith's argument, that poor people need to get better returns on their assets, is equally absurd. For one thing, even staggering returns on the savings of the poor would not help close the gap with barely modest returns on the invested wealth of the rich. For another thing, one of the key takeaways of the Rich Dad book series (not an authority, but insightful), is that most high-yield investment opportunities are only available to investors who are already wealthy, either by law or by practicality given the size or complexity of investment required.

    The role of markets in inequality is challenging. Although I don't have an answer to your puzzle of how to foster equality in a capitalist society, I would like to point out that neoclassical economic models are overt in their use of efficiency as the outcome to maximize. Such theories do not attempt to address the proper balance in the tradeoff between efficiency and equity. That assessment is our responsibility as citizens.

  2. Great post and some really interesting points you bring up with respect to Noah's comments. I agree with most of our post, but there are two things that I might object to: First, expanding credit creates demand in the short run, but it is not sustainable in the long run, as we've seen both in the Great Depression and the 2008 Financial Crisis. Credit has a role in bridging economic possibilities over time and perhaps even as an occasional policy lever to mitigate the peaks and troughs of major economic cycles, but it cant grow forever, because its growth increases its own fragility. We need real sources of growth, which investment in technology and human capital as well as the reduction of inequality itself can be parts of the solution.

    The second thing I would push back on a little is that I appreciate the distinction you are making between inequality of wealth and of income, suggesting that it is the inequality of income that creates the inequality of wealth. That is true to some extent, but the inequality of wealth also causes the inequality of income. Those with more wealth can invest in financial instruments that produce larger and larger shares of their income taxed at lower rates. So, my point is not to discount your distinction, but to suggest it goes both ways.

    1. Definitely agree about expanding credit not being a "real" source of growth. Your point is important not only because debt is a time-bounded solution (debt comes due and can't increase forever) but also because debt has distributional consequences of its own (assuming borrowers are borrowing at rates above inflation).