Dr. David Cowan
You have probably noticed there is increasing talk about economic inequality. There was some debate before the 2008 recession, but it has now become increasingly heightened and shrill since. The underlying thinking of much of what we read on economic inequality is best described as the Pie School of economics.
The first doctrine of the Pie School is that there is a very large pie. The second doctrine is that everyone should get fair shares in this pie. The third doctrine is that the fair share of the pie should be handed to some people on a plate. The fourth doctrine is that the problem we have today is that 1 percent of the population is getting more than its fair share of the pie, which in America represents 20 per cent of the pie going to 1 per cent of the people. Lastly, though not exhaustively, a whole host of inequalities need to be added to the economic question to ensure that the pie is baked the way certain people argue it should be baked.
Of course, the notion that you could go out and bake another pie and set up shop doesn’t seem to enter into the discussion.
The new Pie School narrative post-2008 recession is well outlined by Joseph Stiglitz, who argues that in the US in 2010 the top 1 per cent accounted for 93 per cent of the growth in incomes. This means the middle class is too weak to support the consumer spending, and it is this that has historically driven our economic growth.
As a result, millions of people end up borrowing beyond their means, which makes the economy more volatile and vulnerable to shocks. He wrote, after the fact, that “the fact is the economy in the years before the current crisis was fundamentally weak, with the bubble, and the unsustainable consumption to which it gave rise, acting as life support.” Stiglitz also rejects the idea that greater trade flows will always increase general welfare, suggesting the removal of trade barriers is a euphemism for getting rid of good regulation.
A lot of the Pie School argument for equality is based on creating some kind of world where we create a “reset” in which those who have been born into a poorer station in life will find themselves in a good place. For some this opportunity may well solve their problems, but, and I hate to sound a cynical note, others will simply end up digging themselves into a new hole. The reason? You may succeed in changing the rules, but you haven’t changed the fundamental dynamics of the economy. Nor have you altered human personality.
However, the new Pie School argues something the old Pie School did not argue, which is that inequality is not just about the principle of equality in society. Inequality in fact impedes economic growth. Having lost the battle of principles in the past, the reinvention today takes the tactical approach. Yet if we look at economic history, from the industrial revolution onwards, rooted as the times were in huge inequalities that dwarf ours today, the economy grew and lifted generations out of poverty.
The next convoluted turn in the road of the popular Pie School is the cause of redistribution, which is now focused on ‘predistribution,’ which means dealing with the origins of distribution of incomes and creating a ‘living wage’ for all.
Former leader of the Labour Party of Britain, Ed Miliband, recently wrote an excellent defense of the Pie School doctrine for Prospect magazine. He wrote, rather generously one is to suppose, that “We need, too, a much more open discussion about the top 1 per cent. We should acknowledge the contribution they make as well as the burden they place on everyone else... The entrepreneurs, inventors and software designers who reap big rewards often make a big contribution to the creation and sustaining of jobs, but what balance should be struck between how much they are rewarded – and how much more than others in their companies – and how much they are taxed?”
Pie thinking also had a boost thanks largely to an economics book that has become something of a cause célèbre in the media. Written by a French economist Thomas Piketty, Capital in the Twenty-First Century has become a sell-out book. It is a study of equality and inequality in Europe and the US since the 18th century. It was originally spectacularly ignored in France, but its translation in America created great excitement.
Piketty argues the conclusion that wealth will accumulate if the rate of return on capital is greater than the rate of economic growth, which in the long term leads to the concentration of wealth and economic instability. It comes as no surprise that Piketty proposes a solution: a global system of progressive tax and transfer to help create greater equality and avoid concentration of wealth in the hands of a few. By all accounts the book is well-researched in terms of the data, but like Karl Marx himself, having understood the problem he is fantastically wrong about the solution.
Chicago economist Frank H. Knight noted in the 1920s that inequality is indeed a concern in capitalism. It is, as Piketty’s research suggests, an inherent outcome. But what Knight saw as the outcome of the problem is that large-scale inequality will lead to “reformers” like Piketty, people who will say more government and more taxation are the answers to the problem. If you read Miliband, Stiglitz and Piketty, they all conclude with the same result that what is needed is more government and more taxation. However, as Margaret Thatcher famously said, the problem with socialism is that you eventually run out of other people’s money.
The problem such knee-jerk reactions create is the path that is well-trod with good intentions. It, in fact, leads to a depression of the dynamics that create markets and growth. Some inequality is a necessary outcome of markets, and attempts, however well-intentioned, to erase it are a fool’s errand. Concentration of power, hand in hand with government, will oppress entrepreneurial power that is in fact the driver of the economy. We need policies that will promote entrepreneurship, and bring confidence back into the economy, which in turn will reduce inequalities. This is the rising tide raises all boats argument highlighted by Jack Kemp back in the Ronald Reagan days.
Since the beginnings of capitalism, inequality has spurred many people into action, and to become entrepreneurial, and this is what creates wealth and jobs. If we look at companies old and new in our economy, they have been created by individuals and families at some point and succeed through creativity, reinvention and effort. In other words, they have created new pies. Economic policy should be geared towards this fundamental dynamic, not finding ways to punish and limit the individual outcomes of those who are successful in creating the wealth.
Much of the Pie School thinking and rhetoric is based on breeding resentment in the economy. The reason Pie School thinking and protests have emerged since the recession of 2008 is because this was the first genuinely middle class recession. It impacted the haves the most, and they needed a scapegoat, and found one in “big business” and bankers. There is much to be found wrong in big businesses and banking apart from greed and “fat cats,” there is also cronyism, government-backing and failed regulation. The repeal of the Glass-Steagall Act, for instance, was one of the root causes of the bubble, so government has to take its fair share of the blame.
However, the middle classes must also accept part of the blame. They helped fuel the bubble by treating their homes as investments, speculating on the value of their properties and flipping homes. Many individuals behaved as if they were professional investors, and this explains in part why many borrowed beyond their means. In addition, their own greed got them into trouble by thinking their homes were worth more all the time, as if there were only one direction. The economy has its own law of gravity, as what goes up must come down at some point; all bubbles burst. How did people prepare for that? Not very well.
Recession can be both market-wide and individual. As I Wrote in 2006, before the recession, in Economic Parables: The Monetary Teaching of Jesus Christ, “the fragility of debt is a big picture and small picture thing. The big picture is that we may be living in an economic bubble, and history teaches us that all economic bubbles burst. If this happens, many of us will be in deep trouble. The small picture is that people also experience their own personal bubble. The bubble bursts when they lose their job, get a divorce, and so on. Meanwhile everyone is carrying on business as usual. Debt, essentially, is a relational issue.”
The last doctrine of the Pie School is to find someone else to blame, so that individual irresponsibility is excused. Besides which, I didn’t hear anyone complaining about how high the price tag was on their home when prices were rising, and I didn’t hear too much about inequality then either. Greed is myopic, and it is human behavior not a system.
The problem is, as Knight argued, economics is a hard task and the economy a hard task-master. Knight was a great prophet of economic realism, something which has been lacking for some while in our troubled economic times. Change is not achieved by hollow idealism, and Knight was always suspicious of do-gooders in the economy. I argue along similar lines, in book Economic Parables, that the economy is a reflection of our human endeavors and puts a number on what we are really like. This applies to inequality, because we do not treat each other equally, and this simply shows up glaringly in the economy, it puts a number on it.