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."

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

http://harrisschool.uchicago.edu/faculty/web-pages/Inequality60s.pdf

"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?  

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

 

Greg Mankiw's Blog: What nation has the most progressive tax system?

Based on these numbers, the U.S. has the most progressive tax system in the world by far.

The top 10% of earners earn about 33.5% of all income on the U.S. but pay 45.1% of taxes. They in essence pay 35% more in taxes than what they earn as a share of income.

There is also an interesting discussion on how these numbers are used and interpreted.

http://gregmankiw.blogspot.com/2011/03/what-nation-has-most-progressive-tax.html

Does fair trade promote economic development and lessen the burdens of poverty?

 The Problem with Fair Trade Coffee
By Colleen Haight.  Stanford Social Innovation Review Summer 2011 link


My field and analytical research has found that there are distinct limitations to the Fair Trade model.7 Perhaps the most serious challenge is the extraordinarily high price of coffee. “The market today is five times higher than when FLO entered the United States. The market’s at $2.50 (per pound for commodity coffee) today vs. the 40 cents or 50 cents (per pound) it was at in 2001,” says Dennis Macray, former director of global sustainability at Starbucks Coffee Co. This price shift dampens farmers’ desire to sell their high-quality coffee at the Fair Trade price. Many co-ops, according to Macray, are choosing to default on the Fair Trade contracts, so that they can do better for their members by selling on the open market.


 Fair Trade without the Froth: A Dispassionate Economic Analysis of “Fair Trade” by Sushil Mohan

 Institute of Economic Affairs Nov 4, 2010. link

-research shows that fair trade is not a strategy for long-term development – conventional trade is often more effective.

- analysts sympathetic to the movement have suggested that only 25% of the premium reaches producers.

-Fair Trade does not focus on the poorest countries. Fair Trade penetration is greater in middle income countries, rather than in poor ones. The top four nations by Fair Trade certified producers in 2007 were Mexico, Colombia, Peru and South Africa. These nations had an average GDP per capita of $4,790 in 2007. The thirteen nations with only one Fair Trade certified producer had average GDP per capita of just $2,807 in 2007. Coffee-producing countries with no Fair Trade producers have an even lower average GDP per head. Most significantly, using data from 2005–07 for Fair Trade exports to the USA, it is not possible to find any significant negative relationship between national income per head or poverty and Fair Trade penetration.

Unfair Trade Marc Sidwell. Adam Smith Institute  2008- link

"Economic development throughfree market reform actively favours the poor. Because free markets reduce prices while improving quality, they serve the interests of the poor consumer. Poor nations that open their markets and pursue economic development grow at much faster rates than developed economies, for the latter have already introduced the changes that make the most difference – explaining how Hong Kong could overtake the UK economically despite our head start. Moreover, within nations, economic growth improves life for the poor at least as much as the rest of the population, if not more so the long-term objective of the Fair Trade movement seems to be to create a broad-based constituency with which to achieve radical restrictions on free trade... Rather than emphasising individual consumer choices, the pattern of Fairtrade growth is increasingly corporatist, concentrating on persuading large organizations to declare themselves Fairtrade: Fairtrade schools, towns, and even potentially nations in Scotland and Wales. Choice is steadily removed from the consumer, either because a decision to source only Fairtrade products has been taken on their behalf.."


Absolution in Your Cup - Reason 2006 - link


"Yet given its size, Starbucks likely has done far more than the Fair Trade movement to improve the lot of coffee growers in the 25 countries from which it purchases coffee. Starbucks buys 2.2 percent of the world's coffee production, and its infamous growth fuels demand for high-priced specialty coffees. In 2004 it bought that coffee at an average price of $1.20 a pound, slightly below the $1.26 Fair Trade pays but more than twice the average price for beans on the global commodity market."

Should we boycott or ban products made by sweatshops?

From the New York Times:  Where Sweatshops Are a Dream  by Nicholas D. Kristof January 14,2009

"I often hear the argument: Labor standards can improve wages and working conditions, without greatly affecting the eventual retail cost of goods. That’s true. But labor standards and “living wages” have a larger impact on production costs that companies are always trying to pare. The result is to push companies to operate more capital intensive factories in better-off nations like Malaysia, rather than labor-intensive factories in poorer countries like Ghana or Cambodia.

Among people who work in development, many strongly believe (but few dare say very loudly) that one of the best hopes for the poorest countries would be to build their manufacturing industries. But global campaigns against sweatshops make that less likely.

Look, I know that Americans have a hard time accepting that sweatshops can help people. But take it from 13-year-old Neuo Chanthou, who earns a bit less than $1 a day scavenging in the dump. She’s wearing a “Playboy” shirt and hat that she found amid the filth, and she worries about her sister, who lost part of her hand when a garbage truck ran over her.

“It’s dirty, hot and smelly here,” she said wistfully. “A factory is better.”

The Unbelievable Truth About Sweatshops 

Income, Poverty and Economic Growth

New York Times: You Are What You Spend-

"Income statistics, however, don’t tell the whole story of Americans’ living standards. Looking at a far more direct measure of American families’ economic status — household consumption — indicates that the gap between rich and poor is far less than most assume, and that the abstract, income-based way in which we measure the so-called poverty rate no longer applies to our society."

Wall Street Journal: Income Mobility- U.S. Treasury Study (link)

"The Treasury study examined a huge sample of 96,700 income tax returns from 1996 and 2005 for Americans over the age of 25. The study tracks what happened to these tax filers over this 10-year period. One of the notable, and reassuring, findings is that nearly 58% of filers who were in the poorest income group in 1996 had moved into a higher income category by 2005. Nearly 25% jumped into the middle or upper-middle income groups, and 5.3% made it all the way to the highest quintile.\"

Income Mobility in the U.S. from 1996 to 2005
Report of the
DEPARTMENT OF THE TREASURY

"Economic growth resulted in rising incomes for most taxpayers over the period from 1996 to 2005. Median incomes of all taxpayers increased by 24 percent after adjusting for inflation. The real incomes of two-thirds of all taxpayers increased over this period. In addition, the median incomes of those initially in the lower income groups increased more than the median incomes of those initially in the higher income groups. The degree of mobility in the overall population and movement out of the bottom quintile in this study are similar to the findings of prior research on income mobility."

From the PEW Economic Mobility Studies:

http://cafehayek.com/2009/06/absolute-mobility.html 

  Source: The Myth of Middle-Class Stagnation, Steve Conover


From the October 3rd EconTalk podcast, Bruce Meyer discusses income inequality since the 1960's:

"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

http://harrisschool.uchicago.edu/faculty/web-pages/Inequality60s.pdf 

"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. 

 As Bruce Meyer's work above indicates, you can't just take income related data at face value. If we look at income inequality based on family market income data used by Picketty and Saez teh picture looks pretty bleak:


Saez, Emmanuel. (2012). Striking it Richer: The Evolution of Top Incomes in the United States. (Updated with 2009 and 2010 estimates). http://elsa.berkeley.edu/~saez/saez-UStopincomes-2010.pdf

 However, there are huge differences in outcomes when we consider how we measure income a well as how we account for things like household economies of scale:

"A Second Opinion on the Economic Health of the American Middle Class and Why it Matters in Gauging the Impact of Government Policy," by Richard V. Burkhauser, Jeff Larrimore and Kosali Simon. National Tax Journal, March 2012.

“Researchers considering levels and trends in the resources available to the middle class traditionally measure the pre-tax cash income of either tax units or households. In this paper, we demonstrate that this choice carries significant implications for assessing income trends. Focusing on tax units rather than households greatly reduces measured growth in middle class income. Furthermore, excluding the effect of taxes and the value of in-kind benefits further reduces observed improvements in the resources of the middle class. Finally, we show how these distinctions change the observed distribution of benefits from the tax exclusion of employer provided health insurance”

 For more details about this methodology, see the April 9,2012 EconTalk podcast with Burkhauser:
http://www.econtalk.org/archives/2012/04/burkhauser_on_t.html



CNN Money - CEO Pay

From: http://www.epi.org/publication/webfeatures_snapshots_20060621/ 

From http://www.businessinsider.com/here-are-the-four-charts-that-explain-what-the-protesters-are-angry-about-2011-10?utm_source=twbutton&utm_medium=social&utm_campaign=bi

When considering income, how might the marginal contribution (in terms of the value of output, consumer surplus etc.)  of a CEO vs. the average worker changed over time? Were there changes in capital (which complements labor)? What about the size of the market served by new products?

You can find a very good discussion of these issues from a Cato Daily Podcast here: Steve Jobs, Profit and Social Obligation