Greg Mankiw: Always Look at the Supply Side of Life

      Mankiw has a new PDF defending the 1 percent. It strikes me that this shows some anxiety-he must feel it's getting a little hot in the kitchen... Krugman comments:

       "a quick summary of the argument to date. Mankiw argues that the 1 percent make so much because of their high contribution to output — basically, that they have high marginal productivity. So they earn what they get; and Mankiw further argues that economic opportunity is in fact relatively if not perfectly equal. All’s fair!"

      "The critique falls along three lines. 

     "First, as Dean Baker notes, even if you believe that the glittering prizes at the top of the economic scale were fairly won, the size of those prizes is very much defined by policy choices. We live in a society that allocates rights to intellectual property in a way that yields huge rewards to a select few, that taxes top incomes at a historically low rate, and so on. Even if the game is fair, nothing says that the game has to look the way it does."

     "Second, as Harold Pollack says, Mankiw is way too blithe in dismissing inequality of opportunity. As Pollack says, what we actually see is a very strong tendency for children of the top quintile to stay there; and a look at how that happens suggests that there’s a lot more to that persistence than the inheritance of good genes, which seems to be Mankiw’s main explanation."

     "Third, as The Economist (!) points out, Mankiw’s attempt at a reductio ad absurdum of Ralwsian logic — hey, if we want to equalize results, why not enforce mandatory organ donation! — is just silly. Rawlsian ideas are always a matter of equalization under constraints, where these constraints involve notions of fundamental rights — that’s why Rawls didn’t say “let’s impose perfect equality, and deal with the incentive issue by using forced labor”. As The Economist says, we don’t consider vandalism against property and assault against people equivalent; the same difference makes nonsense of the income taxes = organ donation thing."

     http://krugman.blogs.nytimes.com/2013/06/22/greg-mankiw-and-the-gatsby-curve/?gwh=D0A746BD734AE9F3810A3D3BD51ED85E

    Mankiw's argument, before we even start to read his paper, clearly comes down to the supply side argument. If you think that taxing the rich is a bad idea, you're going to fall back on supply side arguments-their marginal productivity is higher. 

    On the other hand, a Keynesian critic will likely look at it from the opposite direction: the demand side. They'll point out that the marginal propensity to consume is lower for the rich, ergo, we're better off taxing them higher. Mankiw starts off his paper with something of a reductio absurdem argument in starting with a pure, egalitarian society, that an entrepreneur has thrown out of whack. 

   "Imagine a society with perfect economic equality. Perhaps out of sheer coincidence, the supply and demand for different types of labor happen to produce an equilibrium in which everyone earns exactly the same income. As a result, no one worries about the gap between the rich and poor, and no one debates to what extent public policy should make income redistribution a priority. Because people earn the value of their marginal product, everyone is fully incentivized to provide the efficient amount of effort. The government is still needed to provide public goods, such as national defense, but those are financed with a lump-sum tax. There is no need for taxes that would distort incentives, such as an income tax, because they would be strictly worse for everyone. The society enjoys not only perfect equality but also perfect efficiency."

     "Then, one day, this egalitarian utopia is disturbed by an entrepreneur with an idea for a new product. Think of the entrepreneur as Steve Jobs as he develops the iPod, J.K. Rowling as she writes her Harry Potter books, or Steven Spielberg as he directs his blockbuster movies. When the entrepreneur’s product is introduced, everyone in society wants to buy it. They each part with, say, $100. The transaction is a voluntary exchange, so it must make both the buyer and the seller better off. But because there are many buyers and only one seller, the distribution of economic well-being is now vastly unequal. The new product makes the entrepreneur much richer than everyone else."

     "The society now faces a new set of questions: How should the entrepreneurial disturbance in this formerly egalitarian outcome alter public policy? Should public policy remain the same, because the situation was initially acceptable and the entrepreneur improved it for everyone? Or should government policymakers deplore the resulting inequality and use their powers to tax and transfer to spread the gains more equally?"

     http://scholar.harvard.edu/files/mankiw/files/defending_the_one_percent_0.pdf

      There aren't many Keynesians who would argue for perfect equality in the first place. 

     "In my view, this thought experiment captures, in an extreme and stylized way, what has happened to US society over the past several decades. Since the 1970s, average incomes have grown, but the growth has not been uniform across the income distribution. The incomes at the top, especially in the top 1 percent, have grown much faster than average. These high earners have made significant economic contributions, but they have also reaped large gains. The question for public policy is what, if anything, to do about it."

     Again, not many Keynesians would argue that we should impose pure equality as Krugman also underscored above. However, while I for one am not a pure egalitarian-I do agree there needs to be unequal rewards to provide incentive-it's a matter of degree. Inequality has certainly gotten out of hand over the last 30 years and what's really worrisome is that the median American hasn't seen his place improve at all. 

     "Joseph Stiglitz’s (2012) book, The Price of Inequality, spends many pages trying to convince the reader that such rent-seeking is a primary driving force behind the growing incomes of the rich. This essay is not the place for a book review, but I can report that I was not convinced. Stiglitz’s narrative relies more on exhortation and anecdote than on systematic evidence. There is no good reason to believe that rent-seeking by the rich is more pervasive today than it was in the 1970s, when the income share of the top 1 percent was much lower than it is today."

     "I am more persuaded by the thesis advanced by Claudia Goldin and Lawrence Katz (2008) in their book The Race between Education and Technology. Goldin and Katz argue that skillbiased technological change continually increases the demand for skilled labor. By itself, this force tends to increase the earnings gap between skilled and unskilled workers, thereby increasing inequality. Society can offset the effect of this demand shift by increasing the supply of skilled labor at an even faster pace, as it did in the 1950s and 1960s. In this case, the earnings gap need not rise and, indeed, can even decline, as in fact occurred. But when the pace of educational advance slows down, as it did in the 1970s, the increasing demand for skilled labor will naturally cause inequality to rise. The story of rising inequality, therefore, is not primarily about politics and rent-seeking but rather about supply and demand."

      Actually the 'education gap' is itself at least not up to date. It was a lot more persuasive in the 90s-back then, it was mostly the 'blue collar' jobs that were being downsized and displaced. However, what we've seen more since 2000 is not just a gap between workers-where the higher skilled and more educated workers continue to leave the less skilled and educated behind-but a yawning gap between all workers-educated as well as uneducated-and capital. 

      As Krugman notes:

      "Until recently, the conventional wisdom about the effects of technology on workers was, in a way, comforting. Clearly, many workers weren’t sharing fully — or, in many cases, at all — in the benefits of rising productivity; instead, the bulk of the gains were going to a minority of the work force. But this, the story went, was because modern technology was raising the demand for highly educated workers while reducing the demand for less educated workers. And the solution was more education."

     "Now, there were always problems with this story. Notably, while it could account for a rising gap in wages between those with college degrees and those without, it couldn’t explain why a small group — the famous “one percent” — was experiencing much bigger gains than highly educated workers in general. Still, there may have been something to this story a decade ago."

     "Today, however, a much darker picture of the effects of technology on labor is emerging. In this picture, highly educated workers are as likely as less educated workers to find themselves displaced and devalued, and pushing for more education may create as many problems as it solves."

     http://diaryofarepublicanhater.blogspot.com/2013/06/krugman-joins-luddites.html

     Others who largely agree with Krugman question his pessimism about education. Bernstein wouldn't go as far as saying it 'creates as many problems as it solves.'

      http://diaryofarepublicanhater.blogspot.com/2013/06/jared-bernstein-joins-luddites.html

     Yet, clearly the marginal returns of education are decreasing. For one, degrees, even advanced degrees are now so prevalent. For another, so many upon receiving them end up crushed under six figures of debt and either no job or one considerably less than what their degree was supposed to prepare them for. What's more I think it's arguable that since 2000 it's been many of the white collar jobs that have been more vulnerable to the data revolution.

     http://raceagainstthemachine.com/excerpt/

    Much more plausible I find is the idea that the Internet revolution while providing us with tremendous intellectual and social benefits has also had a really negative effect on the job market for many Americans. This argument, by the way, is subtly quite different from Tyler Cowen's  who argues that we've run out of technological innovations. 

    In this argument, technological innovation is proceeding at an absolutely dizzying pace but it's greatly increased worker redundancy. Even the optimists thinks this problem will be solved only gradually. 

    http://diaryofarepublicanhater.blogspot.com/2013/06/luddites-or-digital-optimists.html

    I would put myself with the optimists. I certainly do think that it has led to massive worker displacement, however, I do think the problem will be solved by working with the technology rather than a "Luddite" solution-impotently smashing the machines. . 

     "it seems that changes in technology have allowed a small number of highly educated and exceptionally talented individuals to command superstar incomes in ways that were not possible a generation ago. Erik Brynjolfsson and Andrew McAfee (2011) advance this thesis forcefully in their book Race Against the Machine. They write (p. 44), “Aided by digital technologies, entrepreneurs, CEOs, entertainment stars, and 
financial executives have been able to leverage their talents across global markets and capture 
reward that would have been unimaginable in earlier times.” 

   They are not arguing simply that it's all about education-as if the more education you have the better you are doing; as if all we need is more education-by itself education is not a panacea anymore even if it seemed that way in the 90s. They do look at high vs. low skilled workers but also 'superstars vs. everyone else' and differences in reward between capital and labor. 

    http://www.amazon.com/Race-Against-Machine-Accelerating-ebook/dp/B005WTR4ZI/ref=sr_1_8?s=books&ie=UTF8&qid=1372117262&sr=1-8&keywords=rage+against+the+machine