Tuesday, October 18, 2011

Constitutional Economics: Rent Seeking, Economic Growth, Corporate Power, and Inequality

In other posts I have provided data related to income inequality and economic mobility as well as the concept of rent seeking. In his principles of economics textbook, Greg Mankiw outlines growth promoting policies such as:

1) Reducing corruption in the legal system
2) Increasing reliance on market forces
3) Increasing foreign investment
4) Encouraging trade with other countries
5) Increasing the percentage of GDP devoted to savings

In this post, I attempt to integrate many of these concepts.

While the data show that income inequality is not as severe as often portrayed in the media, and that the U.S. has one of the most progressive tax systems in the world,  income inequality still exists in the U.S.  We know that some degree of income inequality is necessary and desirable (giving us for instance innovations that lead to increased standards of living for the masses). But what are the consequences of unequal distributions of income and wealth?

We can see that negative consequences result if wealthy powerful interests (including high income individuals, wealthy individuals, or corporate interests) are able to utilize the political apparatus to their benefit at the expense of the rest of society. Here in essence we have the specter of rent seeking.  Rent seeking, or using the political apparatus to obtain special privileges or benefits ('rents') from government, diverts resources away from innovations and productive investment. It also creates a winner take all or dog eat dog environment (similar to a prisoner's dilemma or Nash equilibrium) that incentivizes everyone to participate (either on the offense to seek 'rents' or on the defense to prevent some law or restriction on activity).

Economic research (Hernando De Soto, The Mystery of Capital; Lane & Tornell, The voracity effect, American Economic Review 1999) indicates that weak political institutions in the presence of powerful special interests are related to stagnant economic growth.  How can we design institutions to minimize the prevalence of rent seeking behavior?

When we look at current issues related to the economy, such as bailouts, corporate influence on the political process, and concentrations of power and wealth, we see that these issues arise from the intersection powerful governments and corporations.

As public choice economist Dennis Mueller is quoted in the article Public Choice Revolution:
"The larger the state and the more benefits it can confer, the more rent-seeking will occur. The entire federal budget...can be viewed as a gigantic rent up for grabs for those who can exert the most political muscle."

In Federalist #10 the founders made it clear that in a free society that we would have an unequal distribution of income and wealth:

"From the protection of different and unequal faculties of acquiring property, the possession of different degrees and kinds of property immediately results; and from the influence of these on the sentiments and views of the respective proprietors, ensues a division of the society into different interests and parties." 

They were also aware that this may lead to populust uprisings, calling for policies that could be detrimental to a free society: 

"A rage for paper money, for an abolition of debts, for an equal division of property, or for any other improper or wicked project…we behold a republican remedy for the diseases most incident to republican government."

Their proposed solution was a government limited in its power to bestow privilege through constitutional restraint. Economist Thomas Sowell, in his essay, Judicial Activism Reconsidered, describes how limited constitutional government serves to protect minorities and individuals from concentrated power and special interests:

"The federal Constitution is "the supreme law of the land," not because it is more moral than state constitutions or state or federal legislative enactments, but because it represents a larger and more enduring majority. Minorities receive their constitutional rights from that enduring majority to which transient majorities bow, not from whatever abstract moral rights are imagined to exist as a brooding omnipresence in the sky."

Thursday, October 6, 2011

The CPI Couldn't Keep Up With Steve Jobs

From basic principles of economics, we know that measures of inflation based on the CPI are biased because of substitution effects, the introduction of new goods and services, and unmeasured quality changes.

Here is some related insight from Russ Roberts post Stagnation or Mismeasurement at Cafe Hayek: (this was in 2007)

 It is not just a question of the number of new goods and services–it is the pace of innovation  within product categories and how much each of these makes it hard to measure prices with any accuracy....The iPod will be six years old next month. The newly released iPod Classic with 160 GB of memory is $50 cheaper than the original iPod, holds 40 TIMES more songs and also plays color videos and displays photos. It is smaller, lighter and has a better battery. 

We can also add to that the iPhone, iPad, Apple TV .....etc.

EconTalk Podcast on Income Inequality

From the October 3rd EconTalk podcast, Bruce Meyer discusses income inequality since the 1960's (note there is also a brief interesting discussion with measurement problems related to the CPI at the beginning of the podcast):

"Bruce Meyer of the University of Chicago talks with EconTalk host Russ Roberts about the middle class, poverty, and inequality. Many economists and pundits argue that the middle class has made little or no economic progress over the last 30 years, that poverty rates are stagnant or rising, and that inequality has increased dramatically. Meyer, drawing on his research over the last ten years, argues that these conclusions are either false or misleading. He argues that standard measures of economic progress and inequality are based on faulty inflation data or a misplaced focus on pre-tax income instead of post-tax income or consumption. " 
Some excerpts from Meyer's paper:
Consumption and Income Inequality in the U.S. Since the 1960s*
October 18, 2010
Bruce D. Meyer
University of Chicago and NBER
and James X. Sullivan
University of Notre Dame


"Income data primarily come from the ASEC/ADF Supplement to the Current Population Survey (CPS), which is the source for official measures of poverty and inequality in the U.S. We use data from the 1964-2006 surveys which provide data on income for the previous
calendar year."
What we see is that compare the top 10% (90th percentile)to the bottom 10% the ratio o inequality (income for the top 10% / income for the bottom 10%) has increased very little. Adjusting for taxes, the ratio has went from about 5.5 to about 6.25, while adjusting for taxes and transfers, it has increased from about 4.10 to about 5.75. We don't see drastic changes such as a 10 fold change or even a doubling of the gap as the media might impress. Looking at just the last 10-15 years, the change is even smaller. 
If we look at the top 10% of earners vs. the median earners, (often the most popular claims in the is  that the gap between median income earners and the top earners has gotten larger as median income has stagnated over the last 30 years) we see that the ratio has remained changed very little since 1961, going from around 2.0 to about 2.25 adjusting for taxes and transfers, and has been even flatter since the 90's.
 Finally, when compare the median income earners to the bottom 10%, again we find little change in income differences since 1961. There was a growing gap for a period during the 1980's, but those slight increases diminished in the 90's and we finished out 2007 at a ratio right about 2.5 where we started in 1961. 

For additional data related to income inequality, please see my link under TOPICS FOR DISCUSSION are the rich getting richer while the poor get poorer?  

Monday, October 3, 2011

Income Shares and Taxes

Source: http://www.cbo.gov/ftpdocs/88xx/doc8885/EffectiveTaxRates.shtml  Historical Effective Federal Tax Rates: 1979 to 2005 Congressional Budget Office
Source: http://www.cbo.gov/ftpdocs/88xx/doc8885/EffectiveTaxRates.shtml  Historical Effective Federal Tax Rates: 1979 to 2005 Congressional Budget Office
Progressiveness of Income Taxes by Country