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Posts Tagged ‘inequality’

My latest for Learn Liberty looks at proposals for starting an equalization program to redistribute from rich to poor states in the U.S. and finds them wanting. Due to the audience for that blog, I kept that post nontechnical and brief. I’ll reproduce part of it here and then elaborate on some of the complexities and possible counterarguments.

[C]ritics of federalism point to one big disadvantage: federalism, they say, is unfair.

This criticism particularly applies to the fiscal aspect of federalism — that is, the ability of states to choose their own tax burdens and spending levels. The argument runs like this: states have different tax bases per citizen (some are richer than others), so richer states can tax their citizens at lower rates than poorer states, offer more benefits and better public services, or both. In this view, federalism is unfair because it helps the residents of rich states and hurts the residents of poor ones.

I will argue, by contrast, that fiscal federalism actually helps people living in poor states more than people living in rich states.

[…]

But there’s a more fundamental problem with the fairness argument for equalization: it ignores migration. Presumably, we care about the welfare of actual people, not the arbitrary geographic categories they live in. In a federal system in which people can easily move across state borders, migration accomplishes everything an equalization program might, without the negative side effects.

Think about a positive productivity shock, like the emergence of a new, highly profitable industry, which raises real wages in one state. Workers will move from other states to the state with the higher wages. The increase in the labor supply will return real wages to their normal level, at which point the migration flow will stop. Those who have moved have become better off, and even those who have remained in the initially poorer states are, at the end of the day, earning just as much as those in the initially richer state. Being able to pay a lower tax rate in a richer state will only accelerate this process — and ultimately eliminate the rich-state tax advantage.

[…]

[S]ome places are just more desirable to live in than others. These places will tend to have higher home prices and rents and lower wages. Think about it: if I take some of my compensation in the form of higher amenities, I’m willing to earn a lower real money wage. For this reason, nice places to live that don’t have a lot of industry, like New Mexico and Maine, have low real wages, while places that are less nice to live in but do have industry tend to have high real wages (see figure 1).

But New Mexico and Maine residents surely don’t deserve to be subsidized simply because they prefer to take their compensation in a nonpecuniary form, just as North Dakotans and Bay Staters don’t deserve to be taxed for choosing to live in unpleasant places where the market demands their labor.

[…]

Certainly, housing regulation is disrupting equalization through migration in the United States. An equalization program that specifically punished costly states and rewarded low-cost states might discourage excessive development restrictions and get migration flowing more freely again.

But housing regulation might end up being a self-correcting problem. As people flow from high-cost to low-cost areas, eventually the latter will enjoy more agglomeration economies that promote economic growth, and the high-cost areas will start to falter by comparison. By regulating housing so strictly, residents of coastal California, the Boston metro area, and elsewhere may be digging their own graves in the long run.

The argument I’m making here about how migration is a more effective equalizer than fiscal transfers makes some simplifications.

One simplification is that the major reasons why some states have higher per person incomes than others are exogenous productivity shocks and amenities (“desirability”). But there is another important reason: different places just tend to suit workers of different skill sets. If you have access to coal deposits and navigable rivers, you might have developed a steel industry and attracted manual laborers. If you have old, prestigious universities and a seaport, you might have developed high-tech export-oriented industries and attracted highly specialized workers. The latter sort of place will tend to have higher average wages, just because the average skill level of workers is higher.

So what changes about the argument if we relax this simplification and allow states to have different skill mixes? Very little. Yes, Massachusetts can have a lower tax rate than Mississippi because it has higher-skilled, higher-wage workers. But as a result, workers will tend to migrate to Massachusetts, driving pretax wages for Massachusetts workers below where they would be in Mississippi (adjusting for cost of living). Importantly, Massachusetts could still end up having much higher average wages than Mississippi, due to a higher ratio of high-skill to low-skill labor, but the posttax income of any particular worker will tend toward equality between the two states, leaving no benefit to moving from one place to the other. You can’t get around the fact that tax differences between jurisdictions will end up being incorporated into market wages and real estate values. (In real estate economics, this process is called “capitalization.”)

Now, what happens if we assume away labor migration? This is indeed an important change, and it may well make some sense once we talk about multinational federations like Canada. Anglophones might be willing to move to any one of the nine anglophone provinces, while Francophones are stuck in Quebec. Thus, a supporter of equalization could defend the program on the grounds that it is a legitimate way of preventing Francophones from being forced to migrate to anglophone areas or fall irretrievably behind the rest of the country economically.

Still, I wonder whether places like Montreal and Quebec City do not have very different economic profiles from, say, Chicoutimi or Trois Rivieres. There is ample room for labor migration within Quebec. If Quebec itself is large enough that some parts of the province tend to do well while other parts of the province do poorly, it may not need equalization to protect itself from economic shocks.

But let’s say it isn’t large enough. Let’s say there are economic shocks — like import competition, new technologies, and resource discoveries — that could cause Quebec either to race ahead of the rest of the country for 10 or even 20 years or fall behind for a similar length of time. Let’s say the Quebec economy is really volatile. If we don’t want Quebeckers moving out after every adverse shock (or Anglophones moving in when times are good?), an equalization program can help, right?

Possibly. But here’s another alternative: a rainy-day fund. If equalization is really supposed to be insurance against economic volatility, then don’t redistribute from rich to poor provinces, redistribute from rich to poor time periods. The provincial government itself could put away lots of money in cash or retire debt when times are good and take on debt or draw down cash when times are bad. Or if we think provincial governments aren’t competent and far-sighted enough to do this, we could have a program forcing provinces going through better-than-normal times for them to subsidize those going through worse-than-normal times, with the idea that each province comes out balanced over the long run. This insurance-type program might not have as bad incentive effects as equalization, not to mention the unfairness of subsidizing high-amenity places. Still, a publicly run insurance program for provincial budgets will likely create some moral hazard, a reluctance among provincial governments to take politically difficult steps to reduce economic volatility and therefore expected future payouts.

So there you have it. Instead of equalization programs, federal systems should facilitate equalization through migration, or when that is not possible, encourage rainy-day funds or possibly intertemporal insurance for regional budgets.

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At e3ne.org, I have posted some reflections on my last discussion with the Ethics & Economics Challenge students, on the topic of private property rights. The work of Acemoglu, Johnson, and Robinson on how property rights support high levels of development plays a prominent role. Here’s a scatter plot from their famous 2001 paper:

property rights and development

Source: Acemoglu, Johnson, and Robinson (2001)

Economies with greater protection from expropriation have higher per capita incomes. There are plausible reasons to think the relationship is causal. As I note in the post,

If I have a stock of lumber in a warehouse in Oregon, and I hear that a hurricane in New Jersey is causing prices to spike there, I have an incentive to ship lumber there only if I can enjoy the profits of doing so. If the government taxes my profits at 100%, I have no incentive to ship the lumber where it’s needed most. Even if the tax is only 70% or 60%, it reduces my incentives enough that I’m not going to incur a lot of time, effort, and cost to ship the lumber. Similarly, if the government owns the lumber, or no one does, then no one earns the profit from shipping the lumber where it’s needed, and so no one wants to ship the lumber where it’s needed.

Still, private property rights are not sufficient for development:

If private property rights are so great for the economy, why didn’t the economy grow tremendously during the age of classic feudalism, when aristocrats held absolute property rights in their land, and serfs had to work on their estates for low pay? It should be clear that just as prices without property rights do little good, so do property rights without real markets. When a small group of people own vast quantities of land and use their ownership of land to oppress everyone else, you won’t get economic progress. We need private property rights, but they need to be dispersed enough to prevent the biggest property owners from converting their wealth into effectively absolute political power.

For that reason, I’m willing to consider comprehensive redistribution of land in former conquistador states, where owners of the great latifundias work the land inefficiently with hired laborers and convert their market power in the rental market into political power.

The other benefit of private property rights I talked about with the students was environmental. Private property rights can solve the “tragedy of the commons,” whereby people tend to overuse and deplete open-access resources. In that vein, I shared with them this very interesting article on different property regimes in the Maine lobster fishery. Where (communal) property rights are strictly defined and enforced, lobster are not overfished: lobster caught are larger and more mature, and lobstermen earn higher wages.

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Many people are concerned about income and wealth inequality. I am not concerned about economic inequality as such; I care about absolute poverty (how many people live in misery because of wretched physical conditions), and I care about a broad distribution of opportunity (everyone’s having a “fair shot” at economic success), but I don’t see it as a problem if someone earns vastly more money than someone else, just as I don’t see it as a problem that poorer people tend to have more leisure time than richer people. Only those consumed with envy could see economic (or leisure!) inequality simpliciter as a problem, right?

But I actually don’t think people on the left care about economic inequality or leisure inequality or inequality of looks or appealing personalities or anything else of value, in themselves, either. They care about economic inequality because they think it has negative consequences, particularly for political inequality, and because they think it is a symptom of some deeper problem. I disagree on the first count and agree on the second. Let me explain.

Does Inequality Have Bad Consequences?

The fear of the left is that in an unequal U.S., the rich will “buy” politicians to do what they want. As a result, we will get more pollution and more redistribution that flows from the middle class to the rich. The so-called “oligarchy study” (the term “oligarchy” never actually appears in the paper) went viral recently, showing that the preferences of wealthy Americans (and organized interest groups) matter for policy change in the U.S., while, controlling for the preferences of wealthy Americans, the preferences of other Americans make little difference. But wealthy Americans and average Americans actually have similar views on most issues, and where they diverge, the wealthy often have clearly superior views: less likely to loathe immigrants and gays, to fear free trade, to oppose marijuana legalization, and to be narrowly ideological. In addition, the wealthy tend to be more skeptical of taxation and welfare programs than the non-wealthy — your views on whether that difference is problematic may vary according to your views of the welfare state.

Still, let’s assume that the influence of the wealthy on U.S. politics is baleful; does that mean that growing economic inequality would reinforce that baleful influence? It remains unproven whether more inequality will mean that the rich pay more in campaign contributions and get more out in policy terms. The most likely explanation for why the rich are influential is simply that they have similar levels of education and status to politicians and move in the same social circles and care about the same sorts of things. Studies looking at how campaign contributions “buy access” to legislators generally come up with very weak results. To take just one policy example, federal air pollution regulations have always ratcheted up, and air quality in the U.S. is vastly improved relative to 50 years ago, in part due to regulation and in part to technological changes. Rising inequality certainly doesn’t seem to explain these trends.

A bigger problem with the U.S. political economy (more…)

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In my last post on this topic, I described an ideal system of federalism and its advantages and disadvantages. One of the concerns that progressives often have about this kind of federalism, which I wish to take seriously, is that it will lead to a growing gap between the incomes of rich and poor regions (such as states in the U.S.). In this post, I’m going to summarize my findings on the empirical evidence on the relationship between federalism and inequality.

What I want to explain here is the extent to which different countries feature regional convergence or divergence in per capita incomes. That is, in some countries rich regions grow faster than poor ones, and in others poor regions grow faster than rich ones. The way to measure that is with the “annual rate of convergence,” which represents the average rate at which the differences in per capita income between a poor economy and a rich economy disappear, all else equal. A figure of 2% would mean that 2% of the average income difference between a rich and poor economy disappears each year. Even when convergence is happening, that does not mean that measured inequality between regions necessarily goes down, because random shocks can intervene (such as oil discoveries or real estate busts). But it’s a key question whether federalism can cause regional economies to convergence faster or more slowly (or even diverge).

Here is how some countries differ in their measured rate of regional convergence over the 1995-2005 period, the longest and most recent period for which consistent data are available (regions are defined as the subnational tier of government enjoying the greatest economic self-rule, which is in turn defined below: states in the U.S., autonomous communities in Spain, provinces in Canada, Laender in Germany, counties in Denmark, etc.):

Some countries actually experience regional divergence, in which richer regions grow faster than poorer ones: Slovakia, Poland, Ireland, Hungary, the Netherlands, and Japan, most notably. The fastest converger in the sample is the European Union (the 15-member EU prior to the entry of the postcommunist states and Cyprus). In other words, the gap between poorer EU states and richer EU states was erased at a 5% annual clip between 1995 and 2005. Much of this remarkable performance had to do with the steep rise of Ireland, but even when Ireland is excluded, the EU is a star performer among these “countries.”

In the chart above, there is no clear relationship between how (more…)

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Constitutional debates swirling around the PPACA’s individual mandate have much to do with federalism. The core issue the Supreme Court is addressing is whether the federal government has essentially unlimited authority in economic policy, or whether they are yet some areas of economic policy-making (such as whether to compel commerce) exclusive to the states. As someone who believes that constitutions ought to be read according to – I don’t know – what their actual words say, I think the entire act is obviously unconstitutional. Article I, section 8 of the U.S. Constitution permits Congress to legislate in order to “regulate commerce…among the several states.” Thus, Congress has the authority to regulate interstate commerce. Not “anything that might be related somehow to interstate commerce,” plus “anything necessary and proper to any of those things.” Of course, no one on the Supreme Court, except perhaps Clarence Thomas on issues like this one, shares my judicial philosophy.

Putting the constitutional issues to one side, however, I want to address the desirability of the kind of federal system that classical liberals — and, perhaps, Justice Thomas — favor. We can summarize that federal system as follows:

  1. The primary regulatory authorities in the country are state and local governments.
  2. The economic role of the federal government is to ensure a common market: to prevent states from levying barriers to the free flow of goods, services, people, and capital, from tariffs to invidious regulations to local preferences in government procurement.
  3. The national court system protects basic human rights and civil liberties from infringement by federal, state, and local governments.
  4. State and local governments fund their activities almost exclusively out of their own resources. The federal government should not, in general, provide grants to state and local governments.
  5. State governments are politically autonomous, constitutionally sovereign, and independently elected. They may legislate freely within the bounds expressed above.
  6. State governments are permitted to form compacts to deal with externalities. For instance, states may choose to adopt uniform regulations on insurance so that companies can sell the same product in multiple states with a quicker approval process. Because states retain their sovereignty, they are free to enter and withdraw from such compacts at any time.

OK – so what are the arguments against this kind of system? (I go over some of the arguments and evidence in favor here.) One common objection to “states’ rights” is that state governments may violate the civil rights of some of their citizens. I share this concern, one reason I don’t think the term “states’ rights” is appropriate for my position; nevertheless, the concern is addressed with point 3 above. Another objection might be that problems like pollution and endangered species can cross state boundaries. Given a sufficiently small number of states, however, I do not see why they cannot contract with each other to solve their commons problems. What else?

There are two concerns about fiscal federalism that many progressives share that I take seriously: that inter-jurisdictional competition under federalism will undermine the welfare state, and that the system will lead to greater inequality among regions. The first concern (more…)

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The latest Economist has an interesting feature on inequalities among regions within countries. The article compares countries on their ranges in GDP per head (the ratio of richest region to poorest). Thus, we get charts like the following:

But range is an extremely crude concept for measuring inequality. In the U.S., the District of Columbia is by far the “richest” “state,” because its large number of commuter workers generate large GDP without figuring into the denominator. Moreover, the use of the range to illustrate dynamics over time is misleading:

This chart makes it appear that the U.S. has rapidly growing regional inequalities. But the increase here is being driven by D.C. again. The growth of the federal government has concentrated ever more GDP in the District, causing its numbers to look increasingly out of whack with the rest of the country.

A better approach is to compare rates of regional GDP per head convergence. Convergence is the phenomenon whereby poorer economies tend to “catch up” to richer ones. A rough-and-ready benchmark for “good” convergence is an annual rate of about 2%. Econometricians derive rates of convergence in GDP per capita by regressing annualized GDP per capita growth on initial GDP per capita for a dataset of economies. I have calculated regional convergence rates for Canada (provinces and territories), the U.S. (states and D.C.), and the European Union (member states before 2006) over various periods. Here are the results:

The “equalization” column indicates whether the federal system has extensive equalization payments that give grants to poorer regions. The EU does have a nominal equalization program, but it does not redistribute much money. Of these systems, only Canada has a truly extensive equalization program.

Despite this, Canada’s convergence record is the worst of these systems, although the differences between the U.S. and Canada are small. Over the entire 1981-2005 period, U.S. states converged at 1.9% per year, while Canadian provinces did so at 1.6% per year. The EU clearly has the best convergence record, with a massive 8.0% annual convergence rate during the 1995-2005 period, which saw the rapid rise of Ireland, Greece, Spain, and Portugal, relative to the rest of the EU. (Eastern European countries are not included in these numbers, because they had not joined the EU yet.)

This evidence suggests that decentralized federal systems do a pretty good job of getting rid of regional inequalities, even without equalization programs. In a paper currently under “revise-and-resubmit” at an economic geography journal, I present much more formal and systematic evidence to this effect. If and when it is published, I will revisit the topic.

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It has long been commonplace to assert that income inequality has been rising in the U.S. since the 1970s. Following Marc’s post about Robert Reich’s book and my reply to Roderick Long’s argument for moral concern about inequality, I thought readers might be interested in a debate going on at the Economist over new data on U.S. income inequality. Will Wilkinson points up new research showing that the rise in income inequality has been overstated significantly due to the fact that prices for the goods that lower-income consumers disproportionately buy have fallen relative to other goods. He also offers another argument for lack of concern about income inequality as such:

To find that American income inequality has been overestimated is not to find that America’s institutions are closer to some moral ideal than we had thought. Were America’s highest marginal income tax rate a little higher, that would do nothing to reform America’s penal system, to moderate America’s nation-building habit, to reform its de facto apartheid public-school system, or to improve its vicious treatment of undocumented immigrants. Inequality is indeed a frequent side-effect of injustice, but it is benighted to fixate on symptoms to the neglect of the disease. The more time wasted arguing about relatively meaningless abstractions like country-level income inequality, the less is devoted to addressing what ought to be the sources of American shame.

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