Robert Frank's Confusions

Great post by David Henderson.

"Cornell University economist Robert Frank has become the Johnny One Note of economics. His one note: how bad wealth and income inequality (he often doesn't distinguish between the two although he should) are, along with his particular reasoning about why we have such inequality. His reasoning? I'll get to that.

In "The Vicious Circle of Income Inequality," his latest piece in the New York Times, he plays that same note. Here goes. His thoughts are in boxes and my thoughts follow.

Almost every culture has some variation on the saying, "rags to rags in three generations." Whether it's "clogs to clogs" or "rice paddy to rice paddy," the message is essentially the same: Starting with nothing, the first generation builds a successful enterprise, which its profligate offspring then manage poorly, so that by the time the grandchildren take over, little value remains. Much of society's wealth is created by new enterprises, so the apparent implication of this folk wisdom is that economic inequality should be self-limiting. And for most of the early history of industrial society, it was.

This is not an implication at all. Income inequality is a measure at a point in time. You could have rags to rags and, at the same time, high income inequality.

But no longer. Inequality in the United States has been increasing sharply for more than four decades and shows no signs of retreat. In varying degrees, it's been the same pattern in other countries.

You could easily have increased income inequality if the gains from innovation become higher and so innovators reap massive rewards. The measures of income inequality and wealth inequality rise. But their children squander it or, at least, if they have multiple children, dilute it. What Frank implicitly assumes is that the innovators and their children hold on to their wealth for generations. Maybe so, maybe no, but that has little to do with increased income inequality. Moreover, he has essentially pulled a bait and switch. The opening paragraphs, if not the title of his piece, cause the reader to think that Frank will discuss how "rags to rags" is no longer true. Later in the piece, he occasionally asserts it but he never establishes it.

The economy has been changing, and new forces are causing inequality to feed on itself. One is that the higher incomes of top earners have been shifting consumer demand in favor of goods whose value stems from the talents of other top earners. Because the wealthy have just about every possession anyone might need, they tend to spend their extra income in pursuit of something special. And, often, what makes goods special today is that they're produced by people or organizations whose talents can't be duplicated easily.

Wealthy people don't choose just any architects, artists, lawyers, plastic surgeons, heart specialists or cosmetic dentists. They seek out the best, and the most expensive, practitioners in each category. The information revolution has greatly increased their ability to find those practitioners and transact with them. So as the rich get richer, the talented people they patronize get richer, too. Their spending, in turn, increases the incomes of other elite practitioners, and so on.

Could be. I don't know. On the other hand, how often do you hear high earners talking about what a great trip they had to India or China or Peru? If they did, they spent a large amount of money there and I'm willing to bet it wasn't mainly on services offered by other high earners: it was on services offered by relatively poor (relative to us) residents of those relatively poor countries.

More recently, rising inequality has had much impact on the political process. Greater income and wealth in the hands of top earners gives them greater access to legislators. And it confers more ability to influence public opinion through contributions to research organizations and political action committees. The results have included long-term reductions in income and estate taxes, as well as relaxed business regulation. Those changes, in turn, have caused further concentrations of income and wealth at the top, creating even more political influence.

Really? By recently, what time period does he mean? Blank out. So let's look at the most recent income tax legislation, enacted in early January 2013. Did Robert Frank notice how effective high earners were at protecting themselves from high tax rates? They weren't. Singles with income over $400,000 and married couples with income over $450,000 now pay a stiff marginal tax rate of 39.6 percent, up from 35 percent. Some influence. Or how about the Obamacare legislation of 2010? That legislation imposed a 3.8 percent tax rate on net investment income from dividends, interest, and capital gains for singles with a modified adjusted gross income (MAGI) of $200,000 and married couples with a MAGI of $250,000. This kicked in in January 2013. Many high-income people get income from dividends, interest, and capital gains. So the marginal income tax rate for many singles with income of $400,000 and many married couples with income of $450,000 rose in January 2013 from 35% to 43.4%. That's an increase of 24%. Stop those high-income people before they strike again.

I'll grant his point about estate taxes. Those have been reduced.

Relaxed business regulation? Really? Like Sarbanes-Oxley, EPA, Obamacare, Dodd-Frank?

By enabling the best performers in almost every arena to extend their reach, technology has also been a major driver of income inequality. The best athletes and musicians once entertained hundreds, sometimes thousands of people at one time, but they can now serve audiences of hundreds of millions. In other fields, it was once enough to be the best producer in a relatively small region. But because of falling transportation costs and trade barriers in the information economy, many fields are now dominated by only a handful of the best suppliers worldwide.

He's probably right here. But notice the implication. When technology enables the best musicians to serve hundreds of millions, costs fall. We consumers benefit. Is that just a detail to Professor Frank?

Income concentration has changed spending patterns in other ways that widen the income gap. The wealthy have been spending more on gifts, clothing, housing, celebrations and other things simply because they have more money. Their extra spending has shifted the frames of reference that shape demand by others just below them, so these less wealthy people have been spending more, and so on, all the way down the income ladder. But because incomes below the top have been stagnant, the resulting expenditure cascades have made it harder for middle- and low-income families to make ends meet. Despite taking on huge amounts of debt, they've been unable to keep pace with community standards. Interest payments impoverish them while enriching their wealthy creditors.

But if you change what you spend money on in order to keep up with the wealthy Joneses, who is responsible for that choice? I remember Frank, in one of his books or articles, talking about how incredibly fancy and expensive your purchase of a barbecue could get. He went out and bought, if I recall correctly, a barbecue priced at about $400. After reading that, I went to Costco and bought a much nicer barbecue than I had had--and paid $99.

But perhaps the most important new feedback loop shows up in higher education. Tighter budgets in middle-class families make it harder for them to afford the special tutors and other environmental advantages that help more affluent students win admission to elite universities. Financial aid helps alleviate these problems, but the children of affluent families graduate debt-free and move quickly into top-paying jobs, while the children of other families face lesser job prospects and heavy loads of student debt. All too often, the less affluent experience the miracle of compound interest in reverse.

True. But there's a solution: go to a community college for two years, earn your associate's degree, and then go to a state college for 2 years. If you're frugal and get a part-time job, you can get out with under $20,000 in debt. Again, it comes down to choices you make. Frank seems to want to blame the choices of person A on the example set by person B. But there's an old saying, probably the best thing your ever mother every taught you: If you see someone jumping off a cliff, should you jump off the cliff?

More than anything else, what's transformed the "rags to rags in three generations" story is the reduced importance of inherited wealth relative to other forms of inherited advantage. Monetary bequests are far more easily squandered than early childhood advantage and elite educational credentials.

He could be right. I don't know. But for more on how little Frank has thought through creative solutions to the education problem he poses, see this.

As Americans, we once pointed with pride to our country's high level of economic and social mobility, but we've now become one of the world's most rigidly stratified industrial democracies.

I don't know if we're one of the world's most rigidly stratified industrial democracies, but I can point to one of the main stratifiers: federal, state, and local governments that ruin people's lives by throwing them in prison for victimless crimes. Will Professor Frank join me in calling for an end to the drug war?

Given the grave threats to the social order that extreme inequality has posed in other countries, it's easy to see why the growing income gap is poised to become the signature political issue of 2014. Low- and middle-income Americans don't appear to be on the threshold of revolt. But the middle-class squeeze continues to tighten, and it would be imprudent to consider ourselves immune. So if growing inequality has become a self-reinforcing process, we'll want to think more creatively about public policies that might contain it.

It is easy to see, but Frank totally missed it. President Obama has made inequality and his attempt to go after "the rich" a signature theme in his 5 years in office. Also, with Obamacare doing badly, he wants to change the subject.

In the meantime, the proportion of our citizens who never make it out of rags will continue to grow.

Continue to grow? He hasn't even shown that it's grown. And he can't. That's because it hasn't grown. Standards of living for those in the bottom fifth have continued to rise just as they have for the other fifth. 

 Indeed, a way to see that is to take his "rags" metaphor literally and look at how people dress. When I was a kid in a middle-class home in the early 1960s, I had two pairs of pants. My father probably had four or five pairs of pants. Now a friend of mine who works in a cemetery and, with his wife's part-time income, has a family income putting them in the second-from-bottom fifth, has over 10 pairs of pants, 20 shirts, and 3 suits.

For more of my analyses of Robert Frank's views, see here and here."