Last week at Politics and Prose, I had the opportunity to hear Robert Putnam’s book talk for Our Kids: The American Dream in Crisis. In his book, he focuses on data that purport to show a growing divide in income inequality and social unraveling.
Putnam told a personal anecdote about his deteriorating home town in the Rust Belt. If Putnam were able to prove that the shrinking economy from the loss of manufacturing jobs in the Rust Belt proportionately reflected the larger economy in all other sectors, he might have a strong data point, but a personal anecdote is not enough. The availability heuristic is not strong evidence.
So much of the talk concerning income inequality pertains to an unstated premise about social mobility. The widespread fear is not just that the rich are getting richer, but that the rich are getting richer at the expense of the poor. The mental model assumes some fixed share of wealth that exists in the world should be divvied up fairly so as to avoid predation by the strong on the weak. Often, the evidence presented for a “fixed pie” theory is to show the shrinking share of income among the lower quintiles and the growing share of income among the higher quintiles. The problem with this methodology is that it doesn’t actually account for social mobility. To prove that capital is flowing from individuals in the bottom quintile to individuals in the top quintile, we need panel data.
If we don’t analyze with panel data, we might observe the top quintile, profiting from some entirely new high-tech sector, drastically increasing their income by 20% while lower quintiles still increase at 2%. More wealth generated at the top wouldn’t imply material loss for the bottom quintile.
In the Q&A, I pressed Professor Putnam on his methodology, specifically, to what extent he used panel data to show decreased social mobility. After his book signing, he elaborated for me.
Putnam claimed that there was some good panel data for income, but that it couldn’t be used to show current trends in social mobility.
We might suppose that the relevant panel data to measure social mobility would include income, for .
At or so, we might expect people to be generating the most amount of income for their life.
The methodological issue Putnam pointed out was that individual incomes over a lifetime are highly nonlinear. If you were to track a random sample of individuals starting at t=20, very different kinds of individuals would look very similar, but both would appear in the bottom quintile. Specifically, could be -$100,000 for a Harvard pre-law student who’s taking out student loans, and could be $16,000 for a minimum wage job. However, might be $450,000, while might be something like $25,000.
Putnam pointed out that because of how this panel data is measured, the data is always intrinsically 30-40 years out of date. Wait, is this a cop out? Is this methodological laziness?
Just because any one particular study requires 40 years doesn’t mean that we couldn’t observe multiple concurrent staggered studies, with different individuals to show panel data over time. We can imagine Study A starting in 1945 with a batch of individuals at , Study B that tracks at 1950, Study C that tracks at 1955, and so on and so forth. Then, despite nonlinearity in lifetime earnings, we would still be able to see trends in how individuals are or aren’t moving up, out of their birth quintiles.
Matt Bruenig attempts to disprove a conservative talking point about income inequality, that one person’s wealth doesn’t have an effect on another person’s:
First, even if you wrongly think of wealth as a store of money and property created long ago, the distribution of it still impacts people’s lives, especially in America.
I’m already confused. Wealth, as far as I understand it, is the net value of the entity being examined. Net income is a measure of wealth over time. Is there some kind of obfuscation going on here? It seems that there’s imprecise jargon here. “Wealth” isn’t a store of “money,” but “money” is a store of value.
Modern life is fraught with very expensive risks lurking around every corner. A sudden illness or accident could render you disabled and unable to work. A recession or economic restructuring could render you unemployed and render the skills you’ve spent your life learning useless. Reaching old age with inadequate savings could mean living your golden years in poverty.
By what measure is modern life riskier than than the pre-modern era? When exactly was this golden age of low-risk living? This is not just a pedantic semantic objection. By modern standards, life in the pre-modern era was characterized by utter poverty. Until about 1800, no society had experienced sustained growth in per capita income. So, while it may be true that there was less risk in the pre-modern era, because pre-modern people didn’t have as much wealth to lose, I don’t think Bruenig is trying to celebrate the massive gains in per capita wealth after the Industrial Revolution.
Many societies have created robust social insurance systems to protect their populations from these kinds of risks. The U.S. has done so as well, but to a much lesser extent. Because social insurance in the U.S. is so inadequate, it is incumbent upon people to self-insure against these risks. That means they need to have enough wealth to draw upon as a cushion if they end up facing hard times. But here’s where the social contract fails: When the bottom half of the country owns basically none of the country’s wealth, they can’t self-insure against these risks. Instead, they must lead a relatively perilous life in which one misstep or mistake could wreck them and their families.
I think this is confusing because there’s an unstated assumption here, that social insurance is just a state program that redistributes money from the wealthy to the poor. This isn’t Bruenig’s fault, but “social insurance” has become a kind of Newspeak term for state redistribution from the wealthy to the poor. Before the rise of the welfare state, there was a robust history of mutual aid societies. That kind of social insurance wasn’t deployed through governments, and wasn’t relevant to the tax code. In fact, that kind of social insurance often functioned to counteract government institutionalized racism.
There’s an unstated premise that redistribution from the wealthy to the poor would lessen the poor’s vulnerability to financial risks. This is true but irrelevant. Bruenig still hasn’t laid out what the exact negative externality is.
Second, wealth is not just a pile of dead value created in years past. When utilized properly, wealth ensures its owners a share of future income, too.
What is this term “dead value?” What does that even mean? Does it refer to a kind of Marxist labor theory of value, or a marginalist subjective theory of value? What is this caveat, “When utilized properly?” Show your work!
It seems that there’s another unstated assumption here, about capital accumulation. The underlying theory is that once an entity has collected a certain amount of capital, the capital will start generating returns without much attention, and that owners of capital can passively collect interest.
It seems obvious to me that there are significant costs to managing capital, but maybe it’s not so obvious. Most startups fail. Venture capitalists and investment banks are constantly assessing and lending capital from household savers to cash-poor entrepreneurs. The total economic surplus generated by the few successful companies outweighs the deadweight loss from overproduction of failed businesses. Investing isn’t simple; it’s not inevitable that once an entity has a certain amount of capital, there will be easy and steady returns.
Most people seem to equate income with working: You go to your job, do your tasks, and get a paycheck. But this is only half of the story. At a macro-economic level, a nation’s income is divided between owners and workers, with the part flowing to the owners called “capital’s share” and the part flowing to the workers called “labor’s share.” In recent years, capital’s share of the national income has been as high as 37 percent, which is to say 37 cents of every dollar of income in a year goes to passive owners of wealth.
I had hoped when I started reading Bruenig’s article that I might find something other than rehashed social conflict theory. If Bruenig wants to abandon the neoclassical paradigm, he should say so explicitly. If not, then it’s not useful to talk of conflict between capital and labor. Both are mere inputs.
I think I can make Bruenig’s argument stronger than he formulated it here. Bruenig never explained what the negative externality was, but I can hazard a guess. The negative externality exists from whatever institutional arrangements preserve the inequality. That may sound obvious, but I’ll unpack it.
What Bruenig should have argued is not that the wealthy are only wealthy by withholding capital from the poor, but that the wealthy have historically used their wealth in the political process to calcify their social position. Why is a donation to the opera tax-deductible? Why are there home ownership deductions? If there is political power available to be purchased, it will be purchased.