income inequality

Interwar US inequality data are deeply flawed

Vincent Geloso Economics, History , , ,

For some years now, Phil Magness and myself have been working on improving the existing income inequality for the United States prior to World War II. One of the most important point we make concerns why we, as economists, ought to take data assumptions seriously. One of the most tenacious stylized facts (that we do not exactly dispute) is that income inequality in the United States has followed a U-curve trajectory over the 20th century. Income inequality was high in the early 1920s and descended gradually until the 1960s and then started to pick up again. That stylized fact comes from the work of Thomas Piketty and Emmanuel Saez with their data work (first image illustrated below). However, from the work of Auten and Splinter and Mechling et al. , we know that the increase post-1960 as measured by Piketty is somewhat overstated (see second image illustrated below).  While the criticism suggest a milder post-1960 increase, me and Phil Magness believe that the real action is on the left side of the U-curve (pre-1960).

Inequality

NOL1

Why? Here is our case made simple: the IRS data used to measure inequality up to at least 1943 are deeply flawed. In another paper recently submitted, I made the argument that some of the assumptions made by Piketty and Saez had flaws. This did not question the validity of the data itself. We decided to use state-level income tax data from the IRS to compute the state-level inequality and compare them with state-income tax data (e.g. the IRS in Wisconsin versus Wisconsin’s own personal income tax data). What we found is that the IRS data overstates the level of inequality by appreciable proportions.

Why is that? There are two reasons. The first is that the federal tax system had wide fluctuations in tax rates between 1917 and 1943 which means wide fluctuations in tax compliance. Previous scholars such as Gene Smiley pointed out that when tax rates fell, compliance went up so that measured inequality went up. But measured inequality is not true inequality because “off-the-books” income (which was unmeasured) divorced true inequality from measured inequality.  This is bound to generate false fluctuations in measurement as long as tax compliance was voluntary (which is true until 1943). State income taxes do not face that problem as their tax systems tended to be more stable throughout the period. The same is true with personal exemptions.

The second reason speaks to the manner the federal data is presented. The IRS created wide categories with the numbers of taxpayers according to net taxable income (rather than gross income) in each categories. For example, the categories go from 0$ to 1,000$ per filler and then increase by slice of 1,000$ until 10,000$ and then by slices of 5,000$ etc. This makes it hard to pinpoint where to start each the calculations for each of the fractiles of top earners. This is not true of all state income tax systems. For example, Delaware sliced the data by categories of 100$ and 500$ instead. Thus, we can more easily pinpoint the two. More importantly, most state-income tax systems reported the breakdown both for net taxable and gross income. This is crucial because Piketty and Saez need to adjust the pre-1943 IRS data – which are in net income – to that they can tie properly with the post-1943 IRS data – which are in adjusted gross income. Absent this correction, they would get an artificial increase in inequality in 1943. The problem is that the data for this adjustment is scant and their proposed solution has not been subjected to validation.

What do our data say? We compared them to the work of Mark Frank et al. who used the same methodology and Piketty Saez but at the state-level using the same sources. The image below pretty much sums it up! If the points are above the red line, the IRS data overestimates inequality. If below, the IRS underestimates. Overall, the bias tends towards overestimation. In fact, when we investigated all of the points separately, we found that those below the red line result merely from the way that Delaware’s (DE) was adjusted to convert net income into gross income. When we compared only net income-based measures of inequality, none are below the red line except Delaware from 1929 to 1931 (and by much smaller margins than shown in the figure below).

IRS.png

In our paper, we highlight how the state-level data is conceptually superior to the federal-level data. The problem that we face is that we cannot convert those measures into adjustments for the national level of inequality. All that our data do is suggest which way the bias cuts. While we find this unfortunate, we highlight that this would unavoidably alter the left side of the curve in the first graph of this blog post. The initial level of inequality would be less than it is now. Thus, combining this with the criticisms made for the post-1960 era, we may be in presence of a U-curve that looks more like a shallow tea saucer than the pronounced U-curve generally highlighted.  The U-curve form is not invalidated (i.e. is it a quadratic-looking function of time or not), but the shape of the curve’s tails is dramatically changed.

Shares of Income – Common Left Delusions

Jacques Delacroix Current Events , , , , ,

Two big conceptual mistakes are hidden in one small graph that help the leftist delusion.

1. I do not contest the data. I have not checked them. They may be correct. I don’t know; I have another purpose.

2. People who use this graph (though not the makers of the graph, maybe) implicitly assume that those who were in the top income 1% in 1980 are the same as those who are in the top 1% in 2016, or their parents.  The graph says nothing about this. One thing is clear: Steve Job or his parents would not have been in the top 1% in 1980; Steve Jobs would have been, for sure, in 2010, his estate in 2016. The graph does not show the perpetuation of privilege and of inequality, as users almost always imply. Suppose that 100% of those who were in the 1% in 2016 were not (or their parents, or their grandparents) in 1980. This would show a fast change of economic elites. It might pose a problem but not the problem the envious imply when they display the graph.

noldelacroixsharesofincome

The problem here is intellectual passivity.

3. The percentage of income that accrues to a given fraction of the population – including the top 1%  – tells you nothing about how well anyone has fared economically, whether anybody is richer or poorer than he was at the beginning. Here is an example: Suppose, you and I both earn $1,000 at the beginning of the period of observation. Thus, we each get 50% of our joint income (1000/2000). Suppose further that during the period observation, my income doubles while yours quadruples, I am now getting only 33% while you are getting 66% (2000/2000+4000 vs 4000/2000+4000). My share in percentage terms has declined while yours has ballooned. Question: Am I now poorer than I was at the beginning of the period? That’s a “Yes/No” question.; don’t equivocate. The problem is here is failure to understand elementary school math.

The chart is produced by the World Inequality Organization, a single purpose outfit not dedicated to the possibility that inequality may be decreasing. The data it offers have not been certified by the usual scholarly processes  This organization’s executive committee includes Thomas Piketty who could not get his data straight in his best-selling book. He had to refer critics to a website to get his story down. The earlier edition of the same book became famous for not including in US calculations: food stamps, rent support, free medical care, and more, in US welfare recipients’ incomes. I don’t know the others, which may or may not matter. Too many Europeans for my taste. I don’t like it, from 40 years of observation. That last remark is somewhat subjective, of course.

Together these simple comments add up to this critical judgment of the relevant chart: Either, those who use it normally don’t know what they are talking about or, they are not saying anything that matters.

On “strawmanning” some people and inequality

Vincent Geloso Economics, History , , , , , ,

For some years now, I have been interested in the topic of inequality. One of the angles that I have pursued is a purely empirical one in which I attempt to improvement measurements. This angle has yielded two papers (one of which is still in progress while the other is still in want of a home) that reconsider the shape of the U-curve of income inequality in the United States since circa 1900.

The other angle that I have pursued is more theoretical and is a spawn of the work of Gordon Tullock on income redistribution. That line of research makes a simple point: there are some inequalities that are, in normative terms, worrisome while others are not. The income inequality stemming from the career choices of a benedictine monk and a hedge fund banker are not worrisome. The income inequality stemming from being a prisoner of one’s birth or from rent-seekers shaping rules in their favor is worrisome.  Moreover, some interventions meant to remedy inequalities might actually make things worse in the long-run (some articles even find that taxing income for the sake of redistribution may increase inequality if certain conditions are present – see here).  I have two articles on this (one forthcoming, the other already published) and a paper still in progress (with Rosolino Candela), but they are merely an extension of the aforementioned Gordon Tullock and some other economists like Randall Holcombe, William Watson and Vito Tanzi. After all, the point that a “first, do no harm” policy to inequality might be more productive is not novel (all that it needs is a deep exploration and a robust exposition).

Notice that there is an implicit assumption in this line of research: inequality is a topic worth studying. This is why I am annoyed by statements like those that Gabriel Zucman made to ProMarket. When asked if he was getting pushback for his research on inequality (which is novel and very important), Zucman answers the following:

Of course, yes. I get pushback, let’s say not as much on the substance oftentimes as on the approach. Some people in economics feel that economics should be only about efficiency, and that talking about distributional issues and inequality is not what economists should be doing, that it’s something that politicians should be doing.

This is “strawmanning“. There is no economist who thinks inequality is not a worthwhile topic. Literally none. True, economists may have waned in their interest towards the topic for some years but it never became a secondary topic. Major articles were published in major journals throughout the 1990s (which is often identified as a low point in the literature) – most of them groundbreaking enough to propel the topic forward a mere decade later. This should not be surprising given the heavy ideological and normative ramifications of studying inequality. The topic is so important to all social sciences that no one disregards it. As such, who are these “some people” that Zucman alludes too?

I assume that “some people” are strawmen substitutes for those who, while agreeing that inequality is an important topic, disagree with the policy prescriptions and the normative implications that Zucman draws from his work. The group most “hostile” to the arguments of Zucman (and others such as Piketty, Saez, Atkinson and Stiglitz) is the one that stems from the public choice tradition. Yet, economists in the public-choice tradition probably give distributional issues a more central role in their research than Zucman does. They care about institutional arrangements and the rules of the game in determining outcomes. The very concept of rent-seeking, so essential to public choice theory, relates to how distributional coalitions can emerge to shape the rules of the game in a way that redistribute wealth from X to Y in ways that are socially counterproductive. As such, rent-seeking is essentially a concept that relates to distributional issues in a way that is intimately related to efficiency.

The argument by Zucman to bolster his own claim is one of the reason why I am cynical towards the times we live in. It denotes a certain tribalism that demonizes the “other side” in order to avoid engaging in them. That tribalism, I believe (but I may be wrong), is more prevalent than in the not-so-distant past. Strawmanning only makes the problem worse.

On the “tea saucer” of income inequality since 1917

Vincent Geloso Economics, History , , , , , , ,

I disagree often with the many details that underlie the arguments of Thomas Piketty and Emmanuel Saez. That being said, I am also a great fan of their work and of them in general. In fact, I think that both have made contributions to economics that I am envious to equal. To be fair, their U-curve of inequality is pretty much a well-confirmed fact by now: everyone agrees that the period from 1890-1929 was a high-point of inequality which leveled off until the 1970s and then picked up again.

Nevertheless, while I am convinced of the curvilinear aspect of the evolution of income inequality in the United State as depicted by Piketty and Saez, I am not convinced by the amplitudes. In their 2003 article, the U-curve of inequality really looks like a “U” (see image below).  Since that article, many scholars have investigated the extent of the increase in inequality post-1980 (circa). Many have attenuated the increase, but they still find an increase (see here here here here here here here here here). The problem is that everyone has been considering the increase – i.e. the right side of the U-curve. Little attention has been devoted to the left side of the U-curve even though that is where data problems should be considered more carefully for the generation of a stylized fact. This is the contribution I have been coordinating and working on for the last few months alongside John Moore, Phil Magness and Phil Schlosser. 

Blog Figure

To arrive at their proposed series of inequality, Piketty and Saez used the IRS Statistics of Income (SOI) to derive top income fractiles. However, the IRS SOI have many problems. The first is that between 1917 and 1943, there are many years where there are less than 10% of the potential tax population that files a tax return. This prohibits the use of a top 10% income share in many years unless an adjustment is made. The second is that prior to 1943, the IRS reports net income and reports adjusted gross income after 1943. As such, to link post-1943 with pre-1943, there needs to be an additional adjustment. Piketty and Saez made some seemingly reasonable assumptions, but they have never been put to the test regarding sensitivity and robustness. This is leaving aside issues of data quality (I am not convinced IRS data is very good as most of it was self-reported pre-1943 which is a period with wildly varying tax rates). The question here is “how good” are the assumptions?

What we did is verify each assumption to see their validity. The first one we tackle is the adjustment for the low number of returns. To make their adjustments, Piketty and Saez used the fact that single households and married households filed in different quantities relative to their total population. Their idea is that a year in which there was a large number of return was used, the ratio of single to married could be used to adjust the series. The year they used is 1942. This is problematic as 1942 is a war year with self-reporting when large quantities of young American males are abroad fighting. Using 1941, the last US peace year, instead shows dramatically different ratios. Using these ratios knocks off a few points from the top 10% income share. Why did they use 1942? Their argument was there was simply not enough data to make the correction in 1941.  They point to a special tabulation in the 1941 IRS-SOI of 112,472 1040A forms from six states which was not deemed sufficient to make to make the corrections. However, later in the same document, there is a larger and sufficient sample of 516,000 returns from all 64 IRS collection districts (roughly 5% of all forms). By comparison, the 1942 sample Piketty and Saez used to correct only had 455,000 returns.  Given the war year and the sample size, we believe that 1941 is a better year to make the adjustment.

Second, we also questioned the smoothing method to link net income-based series with adjusted-gross income based series (i.e. pre-1943 and post-1943 series). The reason for this is that the implied adjustment for deductions made by Piketty and Saez is actually larger than all the deductions claimed that were eligible under the definition of Adjusted Gross Income – which is a sign of overshot on their parts. Using the limited data available for deductions by income groups and making some assumptions (very conservative ones) to move further back in time, we found that adjusting for “actual deductions” yields a lower level of inequality. This is contrasted with the fixed multipliers which Piketty and Saez used pre-1943.

Third, we question their justification for not using the Kuznets income denominator. They argued that Kuznets’ series yielded an implausible figure because, in 1948, its use yielded a greater income for non-fillers than for fillers.  However, this is not true of all years. In fact, it is only true after 1943. Before 1943, the income of non-fillers is equal in proportion to the one they use post-1944 to impute the income of non-fillers. This is largely the result of an accounting error definition. Incomes before 1943 were reported as net income and as gross incomes after that point. This is important because the stylized fact of a pronounced U-curve is heavily sensitive to the assumption made regarding the denominator.

These three adjustments are pretty important in terms of overall results (see image below).  The pale blue line is that of Piketty of Saez as depicted in their 2003 paper in the Quarterly Journal of Economics. The other blue line just below it is the effect of deductions only (the adjustment for missing returns affects only the top 10% income share). All the other lines that mirror these two just below (with the exception of the darkest blue line which is the original Kuznets inequality estimates) compound our corrections with three potential corrections for the denominators. The U-curve still exists, but it is not as pronounced. When you look with the adjustments made by Mechling et al. (2017) and Auten and Splinter (2017) for the post-1960 period (green and red lines) and link them with ours, you can still see the curvilinear shape but it looks more like a “tea saucer” than a pronounced U-curve.

In a way, I see this as a simultaneous complement to the work of Richard Sutch and to the work of Piketty and Saez: the U-curve still exists, but the timing and pattern is slightly more representative of history. This was a long paper to write (and it is a dry read given the amount of methodological discussions), but it was worth it in order to improve upon the state of our knowledge.

FigureInequality

Is the U-curve of US income inequality that pronounced?

Vincent Geloso Economics , , , , , , , , ,

For some time now, I have been skeptical of the narrative that has emerged regarding income inequality in the West in general and in the US in particular. That narrative, which I label UCN for U-Curve Narrative, simply asserts that inequality fell from a high level in the 1910s down to a trough in the 1970s and then back up to levels comparable to those in the 1910s.

To be sure, I do believe that inequality fell and rose over the 20th century.  Very few people will disagree with this contention. Like many others I question how “big” is the increase since the 1970s (the low point of the U-Curve). However, unlike many others, I also question how big the fall actually was. Basically, I do think that there is a sound case for saying that inequality rose modestly since the 1970s for reasons that are a mixed bag of good and bad (see here and here), but I also think that the case that inequality did not fall as much as believed up to the 1970s is a strong one.

The reasons for this position of mine relates to my passion for cliometrics. The quantitative illustration of the past is a crucial task. However, data is only as good as the questions it seek to answer. If I wonder whether or not feudal institutions (like seigneurial tenure in Canada) hindered economic development and I only look at farm incomes, then I might be capturing a good part of the story but since farm income is not total income, I am missing a part of it. Had I asked whether or not feudal institutions hindered farm productivity, then the data would have been more relevant.

Same thing for income inequality I argue in this new working paper (with Phil Magness, John Moore and Phil Schlosser) which is a basically a list of criticisms of the the Piketty-Saez income inequality series.

For the United States, income inequality measures pre-1960s generally rely on tax-reporting data. From the get-go, one has to recognize that this sort of system (since it is taxes) does not promote “honest” reporting. What is less well known is that tax compliance enforcement was very lax pre-1943 and highly sensitive to the wide variations in tax rates and personal exemption during the period. Basically, the chances that you will report honestly your income at a top marginal rate of 79% is lower than had that rate been at 25%. Since the rates did vary from the high-70s at the end of the Great War to the mid-20s in the 1920s and back up during the Depression, that implies a lot of volatility in the quality of reporting. As such, the evolution measured by tax data will capture tax-rate-induced variations in reported income (especially in the pre-withholding era when there existed numerous large loopholes and tax-sheltered income vehicles).  The shift from high to low taxes in the 1910s and 1920s would have implied a larger than actual change in inequality while the the shift from low to high taxes in the 1930s would have implied the reverse. Correcting for the artificial changes caused by tax rate changes would, by definition, flatten the evolution of inequality – which is what we find in our paper.

However, we go farther than that. Using the state of Wisconsin which had a tax system with more stringent compliance rules for the state income tax while also having lower and much more stable tax rates, we find different levels and trends of income inequality than with the IRS data (a point which me and Phil Magness expanded on here). This alone should fuel skepticism.

Nonetheless, this is not the sum of our criticisms. We also find that the denominator frequently used to arrive at the share of income going to top earners is too low and that the justification used for that denominator is the result of a mathematical error (see pages 10-12 in our paper).

Finally, we point out that there is a large accounting problem. Before 1943, the IRS provided the Statistics of Income based on net income. After 1943, there shift between definitions of adjusted gross income. As such, the two series are not comparable and need to be adjusted to be linked. Piketty and Saez, when they calculated their own adjustment methods, made seemingly reasonable assumptions (mostly that the rich took the lion’s share of deductions). However, when we searched and found evidence of how deductions were distributed, they did not match the assumptions of Piketty and Saez. The actual evidence regarding deductions suggest that lower income brackets had large deductions and this diminishes the adjustment needed to harmonize the two series.

Taken together, our corrections yield systematically lower and flatter estimates of inequality which do not contradict the idea that inequality fell during the first half of the 20th century (see image below). However, our corrections suggest that the UCN is incorrect and that there might be more of small bowl (I call it the Paella-bowl curve of inequality, but my co-authors prefer the J-curve idea).

InequalityPikettySaez.png

Did Inequality Fall During the Great Depression ?

Vincent Geloso Economics, History , , , , ,

Inequality

The graph above is taken from Piketty and Saez in their seminal 2003 article in the Quarterly Journal of Economics. It shows that inequality fell during the Great Depression. This is a contention that I have always been very skeptical of for many reasons and which has been – since 2012 – the reason why I view the IRS-data derived measure of inequality through a very skeptical lens (disclaimer: I think that it gives us an idea of inequality but I am not sure how accurate it is).

Here is why.

During the Great Depression, unemployment was never below 15% (see Romer here for a comparison prior to 1930 and this image derived from Timothy Hatton’s work). In some years, it was close to 25%. When such a large share of the population is earning near zero in terms of income, it is hard to imagine that inequality did not increase. Secondly, real wages were up during the Depression. Workers who still had a job were not worse off, they were better off. This means that you had a large share of the population who saw income reductions close to 100% and the remaining share saw actual increases in real wages. This would push up inequality no questions asked. This could be offset by a fall in the incomes from profits of the top income shares, but you would need a pretty big drop (which is what Piketty and Saez argue for).

There is some research that have tried to focus only on the Great Depression. The first was one rarely cited NBER paper by Horst Mendershausen from 1946 who found modest increases in inequality from 1929 to 1933. The data was largely centered on urban data, but this flaw works in favor of my skepticism as farm incomes (i.e. rural incomes) fell more during the depression than average incomes. There is also evidence, more recent, regarding other countries during the Great Depression. For example, Hungary saw an increase in inequality during the era from 1928 to 1941 with most of the increase in the early 1930s. A similar development was observed in Canada as well (slight increase based on the Veall dataset).

Had Piketty and Saez showed an increase in inequality during the Depression, I would have been more willing to accept their series with fewer questions and doubts. However, they do not discuss these points in great details and as such, we should be skeptical.

Inequality and Regional Prices in the US, 2012

Vincent Geloso Economics , , , , , , , ,

I have just completed a short piece on the impact of regional prices on the measurement and geographic distribution of low income individuals. Basically, Youcef Msaid and myself* used the March 2012-CPS data combined the BEA’s regional purchasing power parities database to correct incomes.

We found is that the level of inequality is very modestly overestimated (0.5%). Now this is a conservative estimate since we used state-level corrections for price differences. This means that we took price corrections for New York state as a whole even if there are wide differences within New York state. Obviously, with more fine-grained price-level adjustments we would find a bigger correction but it is hard to imagine that it could surpass 1-3%.

That was not our most important result. Our most important result relates to where the bottom decile of the income distribution is geographically located. We find that instead of being found disproportionately (relative to their share of the total US population) in poorer states, the bottom decile is disproportionately found in rich states. The dotted black line in the figure below illustrates the change in the number of individuals who are, nationally, in the bottom 10%. New York and California have significant increases while West Virginia has a large decrease. The dark black line shows the same for the top 10%.

fig2

Another way to grasp the magnitude of this change is to relate the change to the population shares of each decile by state. For example, New York had 6.29% of the US population in 2012 and 6.61% of all Americans in the bottom 10% of the income distribution before adjusting for regional purchasing parities. After adjusting however, New York’s share of the bottom 10% surges to 7.88%.

Why does it matter? Because most of the cost difference adjustments come from differences in housing costs. The first obvious point is that housing is a crucial aspect of any discussion of inequality. The second, but less obvious point,  is that these differences are massive barriers to migration within the United States and the poorest are those for whom these barriers are the heaviest. Unfortunately, the high-cost areas are also high-productivity areas (New York, San Francisco for example) whose high costs are largely the result of restrictions on the supply of housing. This means that high-productivity areas – which would raise the wages of low-skilled and low -income workers are inaccessible to them. It also means that those who were present before the increase in productivity of these areas capitalized the gains in more valuable real estates (even if this means lower real incomes).

In this light, the geographic reallocation of the bottom 10% is consistent with an emerging literature that argues that inequality is in great a result of housing policy (see notably Rognlie’s reply to Piketty in the Brookings Papers).  This small modification (I consider it small) that me and Youcef made has important logical ramifications.

* Thank you to my friends Rick Weber (who blogs here at NOL and whose research can be seen here) and Ryan Murphy (whose research can be found here) who provided good comments to bring the paper to the stage where we are ready to submit.

What is Wrong with Income Inequality? Five Reasons to be Concerned

Zachary Woodman Economics, Liberty, Politics , , , , , , , , ,

I sometimes part ways with many of my libertarian and classical liberal friends in that I do have some amount of tentative concern for income/wealth inequality (for the purposes of this article, the otherwise important economic distinction between the two is not particularly relevant since the two are strongly correlated with each other). Many libertarians argue that inequality ultimately doesn’t matter. There is good reason to think this drawing from the classic arguments of Nozick and Hayek about how free exchange in a market economy can often interrupt preferred distributions.

The argument goes like this: take whatever your preferred distribution of income is, be it purely egalitarian or some sort of Rawlsian distribution such that the distribution benefits only the worst off in society. Assume there is one individual in the economy who has some product or service everyone wants to buy (in Nozick’s example it was Wilt Chamberlain playing basketball), and let everyone pay a relatively small amount of income to that one individual. For example, assume you have a society with 10,000 people all who start off with an equal endowment of $5 and all of them decide to pay Wilt Chamberlain $1 to watch him play basketball. Very few people would object to those individual exchanges, yet at the end Wilt Chamberlain ends up with $10,005 dollars and everyone else has $4, and our preferred distribution of income has been grossly upset even though the individual actions that led to that distribution are not objectionable. In other words, allowing for free exchange precludes trying to construct an optimal result of that free exchange (a basic consequence of recognizing spontaneous order).

Further, these libertarians argue, it is more important to ensure that the poor are better off in absolute terms than to ensure they are better off relative to their wealthier peers. Therefore, if a given policy will increase the wealth of the wealthiest by 10% and the poorest by 5%, there is no reason to oppose this policy on the grounds that it increases inequality because the poor are still made richer. Therefore, it is claimed, we should focus on policies that improve economic growth and the incomes of the poor and be indifferent as to its impact on relative inequality, since those policies are strongly correlated with bettering the economic conditions of the poor. In fact, as Mises Argued in Liberalism and the Classical Tradition, a certain amount of inequality is necessary for markets to function: they create a market for luxury goods that can be experimented and developed into future mass-consumption goods everyone can consume. Not everyone could afford, for an example, an IPod when it first came out, however today MP3 players are cheap and plentiful because the very wealthy were able to demand it when it was very expensive.

I agree with my libertarians in thinking that this argument is largely correct, however I do not think it proves, as Hayek argued, that social justice (understood in this context as distributive justice) is a “mirage” or that we should be altogether unconcerned with wealth or income distributions. All this argument does is mean that there is no overall deontological theory for an ideal income distribution, but there still might be good consequentialist reasons to think that excessively unequal distributions can impact many of the things that classical liberals tell us to worry about, such as the earnings of the poor, more free political economic outcomes, or overall economic growth. Further, even on Nozick’s entitlement theory of justice, we might oppose income inequality if it arises through unjust means. Here are five reasons why libertarians and classical liberals should be concerned about income inequality (note that they are mostly empirical reasons, not claims about the nature of justice):

1) Income Inequality as a Result of Rent Seeking

Certain government policies result in uneven income distribution. For an example, a paper by Patrick MacLaughlin and Lauren Stanley at the Mercatus Center empirically analyze the regressive effects of regulatory policy. Specifically, Stanley and MacLaughlin find that high barriers to entry create barriers to entry which worsens income mobility. Poorer would-be entrepreneurs cannot enter the market if they must, for an example, pay thousands of dollars for a license, or spend a large amount of time getting costly education and certifications to please some regulatory bureaucracy. This was admitted even by the Obama Administration in a recent report advising reform of occupational licensing laws. As basic public choice theory teaches, regulators are subject to regulatory capture, in which established business interests lobby regulators to erect barriers to entry to harm would-be competitors. Insofar as inequality is a result of such rent-seeking, libertarians have an obvious reason to oppose it.

Many other policies can worsen inequality. When wealthy corporations receive artificial monopolies from policies such as excessive intellectual property laws, insulating them from competition or when they gain wealth at the expense of poorer taxpayers through improper subsidies. When the government uses violent policing tactics to unequally enforce drug laws against poorer communities, or when it uses civil asset forfeiture to take the property of the worst off. When the government uses eminent domain to take the property of disadvantaged individuals and communities in the name of public works projects, or when they implement minimum wage laws that displace low-skilled workers. Or, if the structure of welfare benefits discourages income mobility, which also worsens inequality. There are a myriad of bad government policies which benefit the rich and exploit the poor, some of which are a direct result of rent-seeking on behalf of the wealthy.

If the rich are getting richer, or if the poor are stopped from becoming wealthier, as a result of government coercion, even Nozick’s entitlement theory of justice calls for us to be skeptical of the resulting income distribution. As Matt Zwolinski argues, income distributions are not only a result of, pace Nozick, a result of the free exchanges of individuals, but they are also a result of the institutions in which those individuals exchange. Insofar as inequality is a result of unjust institutions, we have good reason to call that inequality unjust.

Of course, that principle is still very hard to empirically apply. It is hard to tell how much of an unequal distribution is a function of bad institutions and how much is a function of free exchange. However, this means we can provide very limited theories of distributive justice not as constructivist attempts to mold market outcomes to our moral desires, but as rough rules of thumb. If it is true that unequal distributions are a function of bad institutions, then unequal distributions should cause us to re-evaluate those institutions.

2) Income Inequality and Government Exploitation
Of course, many with more Marxist inclinations will argue that any amount of economic inequality will inherently result in class-based exploitation. There are very good, stand-by classical liberal (and neoclassical economic) reasons to reject this as Marxian class analysis as it depends on a highly flawed labor theory of value. However, that does not mean there is not some correlation between some notion of macro-level exploitation of the worst-off and high levels of inequality which libertarians have good reason to be concerned about, for reasons closely related to rent-seeking. Those with a high amount of economic power, particularly in western democracies, are very likely to also have a strong influence over the policies set by the government. There is reason to fear that this will create a class of wealthy people who, through political rent-seeking channels discuss earlier, will control state policies and institutions to protect their interests and wealth at the expense of the worst-off in society. Using state coercion to protect oneself at the expense of others is, under any understanding of the term, coercion. In this way, income inequality can beget rent-seeking and regressive policies which lead to more income inequality which leads to more rent-seeking, leading to a vicious political-economic cycle of exploitation and increasing inequality. In fact, even early radical classical liberal economists applied theories of class analysis to this type of problem.

3) Inequality’s Impacts on Economic Growth

There is a robust amount of empirical literature suggesting that excessive income inequality can harm economic growth. How? The Economist explains:

Inequality could impair growth if those with low incomes suffer poor health and low productivity as a result, or if, as evidence suggests, the poor struggle to finance investments in education. Inequality could also threaten public confidence in growth-boosting policies like free trade, says Dani Rodrik of the Institute for Advanced Study in Princeton.

Of course, this is of special concern to consequentialist classical liberals who claim we should worry mostly about the betterment of the poor in absolute terms, since economic growth is strongly correlated with bettering living standards. There is even some reason for these classical liberals, given their stated normative reasons, to (at least in the short-term given that we have unjust institutions) support some limited redistributive policies, but only those that are implemented well and don’t worsen inequality or growth (such as a Negative Income Tax), insofar as it boosts growth and helps limited the growth of rent-seeking culture described with reasons one and two.

4) Inequality and Political Stability

There is further some evidence that income inequality increases political instability. If the poor perceive that current distributions are unjust (however wrong they may or may not be), they might have social discontent. In moderate scenarios, (as the Alsenia paper I linked to argue) this can lead to reduced investment, which aggravates third problem discussed earlier. In some scenarios, this can lead to support for populist demagogues (such as Trump or Bernie Sanders) who will implement bad policies that not only might harm the poor but also limit individual liberty in other important ways. In the most extreme scenarios (however unlikely, but still plausible), it can lead to all-out violent revolutions and warfare. At any rate, libertarians and classical liberals concerned with ensuring tranquility and freedom should be concerned if inequality increases.

5) Inequality and Social Mobility

More meritocratic-leaning libertarians might say we should be concerned about equal opportunities rather than equal outcomes. There is some evidence that the two are greatly linked. In particular, the so-called “Great Gatsby Curve,” which shows a negative relationship between economic mobility and income inequality. In other words, unequal outcomes can undermine unequal opportunities. This can be because higher inequality means unequal access to certain services, eg. Education, that can enable social mobility, or that the poorer may have fewer connections to better-paying opportunities because of their socio-economic status. Of course, there is likely some reverse causality here; institutions that limit social mobility (such as those discussed in problem one and two) can be said to worsen income mobility intergenerationally, leading to higher inequality in the future. Though teasing out the direction of causality empirically can be challenging, there is reason for concern here if one is concerned about social mobility.

The main point I’m getting at is nothing new: one need not be a radical leftist social egalitarian who thinks equal economic outcomes are necessarily the only moral outcomes to be concerned on some level with inequality. How one responds to inequality is empirically dependent on the causes of the problems, and we have some good reasons to think that more limited government is a good solution to unequal outcomes.

This is not to say inequality poses no problem for libertarians’ ideal political order: if it is the case that markets inherently beget problematic levels of inequality, as for example Thomas Piketty claims, then we might need to re-evaluate how we integrate markets. However, there is good reason to be skeptical of such claims (Thomas Piketty’s in particular are suspect). Even if we grant that markets by themselves do lead to levels of inequality that cause problems 3-5, we must not commit the Nirvana fallacy. We need to compare government’s aptitude at managing income distribution, which for well-worn public choice reasons outlined in problems one and two as well as a mammoth epistemic problem inherent in figuring out how much inequality is likely to lead to those problems, and compare it to the extent to which markets do generate those problems. It is possible (very likely, even) that even if markets are not perfect in the sense of ensuring distribution that does not have problematic political economic outcomes, the state attempting to correct these outcomes would only make things worse.

But that is a complex empirical research project which obviously can’t be solved in this short blog post, suffice it to say now that though libertarians are right to be skeptical of overarching moralistic outrage about rising levels of inequality, there are other very good empirical reasons to be concerned.

Canadian Megatrends: Top 1% income share and median age

Vincent Geloso Economics, Liberty , , , , ,

Statistics Canada just came up with a study on the top income share of the top 1% in Canada. As I have explained elsewhere, my view of inequality is that: a) it has increased; b) not as much as we think; c) a lot of the increase is from desirable factors (personal utility maximization differing from income maximization or international immigration) or neutral factors (demography, marriage); d) that the inequality that is worrisome stems either from birth or government manipulations of the market and; e) that those stemming from government manipulations, direct (like subsidizing firms) or indirect (like the war on drugs which means that a large number of individuals are jailed and then released with a “prison earnings penalty” which stymies their income levels and growth), are the easiest to fight.

The recent Statistics Canada study allows me to make my point again with regards to element C of my answer. As I looked at their series, all I could think was “median age”. A lot of the variations seem to be related to the median age of the population. I went back to the census data I had collected for my book and plotted it against the data. This is what it looks like.

medianage

Why would there be a relation? Well, each year you measure the income distribution, the demographic structure of that population changes. As it grows older, you have more people at the top of their earnings curve relative to those at the bottom. Not only that, but earnings curve seem elongated in recent times – we live longer and so some people work older as witnessed by increased labor force participation rates above a certain age closer to retirement. And the heights of the earnings curve are now higher than ever before while we also enter later into the labor market.

Now, I am not sure how much aging would “explain away” rising inequality in Canada, but there is no point denying that it does explain some of it away. But, I would not be surprised that a large part is explained away. Why am I saying that? Because of this paper on Norway’s age structure. 

In Norway, the median age in 1950 was much higher than it was in Canada back then and today, it is roughly the same as Canada (although Canada has had a steeper increase in inequality). And according to the paper on Norway, adjusting for composition bias in inequality measures caused by aging, eliminates entirely the upward trend in that country. In fact, it may even reverse the trend whereby inequality adjusted for age has actually declined over time. This is a powerful observation. Given that Canada has had a steeper increase in median age, this suggests that the increase in inequality might be simply the cause of a statistical artifice.

The most depressing thing with Chetty et al.

Vincent Geloso Economics, Liberty , , , , , , ,

The Chetty et al. paper has been on my mind over the weekend (see Saturday’s post). The one thing that has moved more or less in line with the absolute mobility measure of Chetty et al. has been…the size of government.

I know that as soon as some of you read the last four words on the previous paragraphs, your eyes rolled. However, even from a social-democratic perspective, it is depressing! It is not the first time I make this observation.   In the pages of Essays in Economic and Business History, I recently reviewed Unequal Gains (authored by Peter Lindert and Jeffrey Williamson and published at Princeton University Press) and I observed that the “great leveling” they observed from the 1910s to the 1970s had a lot to do with the northward migration of American blacks, the closing of the gender wage gap and the convergence of the southern states. I also observed that the increase in inequality in the United States after 1970 occurred at the same time as an the state grew more in size and scope (see blog post here).

However, as I mentioned elsewhere, I am very skeptical of the tax-based data on inequality in the United States and I am afraid to push that point. However, the Chetty et al. data provides further confirmation: trends in inequality/social mobility deteriorates as the state becomes more active (see the graph below).

sizegov

Now, I am aware that the causality can cut both ways. It may be that inequality (economic mobility) is rising (falling) in spite of increasing state action, it may be that state action is fueling the the rise (reduction) of inequality (economic mobility) or it may be that the state has no effects whatsoever on the evolution. Regardless of which of the three viewpoints you tend to adopt (I lean towards a mixture the second option – see my paper with Steve Horwitz here which is under consideration for publication), the implications are immensely depressing with regards to social policy in the last 75 years.

Chetty et al and the metamorphosis of the earnings curve

Vincent Geloso Economics , , , , , , , ,

The Chetty et al. paper is probably one of the most important papers of 2016 and it will long be debated. Many comments have been made on this and I need to reiterate that I do not believe the trend to be off, merely the level. I have just found another reason to doubt the level by thinking about demography. It relates to one key methodological decision made in the paper: taking the income of parents in the 25 to 35 years old age-window. This is a fixed window where their incomes are compared to that of a child at age 30.

This is probably a flaw that alters the level evolution importantly. My argument is simple. A person born in 1940 was, by the time he was 30, close to his peak earning point. A person born in 1980, by the time he is 30, is further away from a higher peak earning point. Thus, you are not comparing the same type of birth cohorts. In simpler terms, I am saying that with the 1940 birth cohort you are comparing children who, by age 30, were at the apex of their earnings while those of the 1980 birth cohort were not at the apex.

From the work of Ransom and Sutch on the economic history of aging in the United States, I remembered that graph (for late 19th century Michigan).  What I see is that for most workers, by 30 years of age, they are pretty much at the top of their earnings cure. Over time, if the shape of the curve does not change and simply keeps moving upwards, then there are no problems with the level of absolute mobility measured by Chetty et al.

earningfunctionsusa1890

But here is the problem, the curve does change shape! There are no longer flat lines like that of the Michigan farm laborers in the figure above. Earnings curve look more and more like that of the Michigan railroad employees. Not only that, the peak point is now higher in terms of income and at a further point in time. And that makes sense since we are studying longer and working menial jobs while we do for which we earn low incomes. When we enter the labor force, we get a very steep rise at a later point in our lives than our fathers or mothers did. So the earning curve of younger cohorts is more skewed than that of earlier cohorts. Kitov and Kitov shows the evolution of income by age groups relative to a fixed groups and as one can see, the youngest are getting further away from the peak over time – implying that it is shifting.  Again, from Kitov and Kitov, you can see that the 2013 curve starts later and has a steeper curve than the 1967 curve. From this trend in the earnings curve, we can more or less be certain that by 30, a person born in 1940 was closer to peak earnings than a person born in 1980. Thus, the person born in 1940 is at his apex (by the time he turns 30) when compared to his parents and the person born in 1980 is not at his apex when compared to his parents. (I am only using Kitov and Kitov for the sake of showing the evolution but this metamorphosis of the curve, I think, is not in dispute).

So, by setting the boundaries for measuring absolute mobility at a fixed point, Chetty et al. are capturing some changes that are purely related to changing demographics of the labor market and not absolute mobility. The 1940 level of mobility is too high relative to that of 1980. Chetty et al. do try to address this by looking at different time windows (they just don’t have a “rolling age window” which would be ideal – like indexing to the median age of the population).

I do accept that mobility has fallen since 1940, but I am very skeptical about how robust the big drop shown actually is. The issues of changes in family size, price deflators, taxes and transfers made me willing to entertain a fall of 25-30 points (rather than 40-45), now with this issue of the metamorphosis of the earning curves in mind, I am inching towards 20-25 points drop (still substantial).

Note: Still a big fan of Chetty et al. and their works is crucial, that’s why I don’t want pundits to try and extract this beyond what it actually says and does not say.

Sons outearning Fathers in Chetty et al. : working hours should be considered

Vincent Geloso Economics, Liberty , , , , , , , , ,

In response to my post yesterday, my friend and economist/nuclear engineer (great mix) Laurent Béland pointed out that the Father-Sons mobility figures in Chetty et al. are depressing. Yes, at first glance, they are (see below – the red line). fathersons

But, at second glance, it is not as terrible. Think about family structures with the 1940 birth cohorts. The father works and, in most likelihood, the mother is a stay-at-home father. Most of the earnings come from the father who probably works 45 to 60 hours a week.  If my father earns 40,000$ at 60 hours a week or earn 40,000$ at 40 hours a week, the line remains at the same height, but we are not talking about the same living standard in reality. Chetty et al. do not account for hours worked to achieve income.  The steep decline – faster than the baseline of household-size adjusted decline – matches the steep increase in female labor force participation and the decline labor force participation of males (see graph here and Nicolas Eberstadt’s work here) as well as the decline in hours worked by males.

If the question had been “what are your chances of out-earning your father per hour worked”, then the red line would not have fallen like that. Income divided by labor supplied would probably bring the red-line back with the blue-line.

Note: Again, please note that I am not trying to rip apart Chetty et al. (as some have claimed elsewhere). Their work is great and as a guy who does all his research on providing data series regarding economic history, I am never going to rip on someone who does hard data work like Chetty et al. did ! My point is that I am not convinced that the decline is so big. And, in good faith, it seems that Chetty et al. do try to put the “caution” labels where its needed – and its important to discuss those caution labels before some politician or two-cents-pundit goes all Trump on us by saying stuff that this doesn’t say!

A flaw regarding the chance of “out-earning” your parents

Vincent Geloso Economics , , , , , ,

When Raj Chetty publishes a paper, it generally comes with a splash. The last one is no exception. His paper (co-authored), picked up by David Leonhardt at the New York Times and Justin Wolfers on Twitter, basically measures the American dream : what are your chances to do better than your parents. The stunning conclusion is that someone born in 1940 had a 90%+ chance of “out-earning” his parents compared with a few points above 50% for those born in the 1980s. I am not convinced. Well, when I am not convinced, I am saying I am not convincing about how big the drop is! I think the drop is smoother (the slope of decline is gentler) and the starting point for the 1940 cohort is too high.  As a big fan of Chetty, I must press this point.

More precisely, I am saying that the bar (income threshold) over which someone had to jump in 1940 is underestimated and overestimated in 1980. Setting the bar too low (high) means very high (low) chances of “out-earning” your parents. To set the bar too low, you must underestimate (overestimate) the income of the parents.  This could occur if household economies of scale are not accounted for.

An income of 30,000$ for 3 persons is not the same as an income of 60,000$ for 6 peoples. On a per capita basis, the income is the same. But, if you adjust for economies of scale in housing and furnitures, there are differences (the simplest is square root).  This gives you income per adult equivalent. Chetty et al. are aware of that and they provided a sensitivity analysis which is not mentioned by those who are relaying the article. Since household size has tended to fall over time, the growth in per capita income is faster than the growth in income per adult equivalent (a better measure). Any correction for this long-term demographic trend would attenuate the slope of the decline of the chance to out-earn your parents. And indeed, once Chetty et al. make the correction, the decline is much more modest (but still present – see below).

size

Simultaneously, Chetty et al. also present other important sensitivity checks. All of them relevant. But, in a strange decision, Chetty et al. decided to isolate each of the sensitivity checks rather than compile them. Taken individual, they all seem minor – except adjusting for family size. But compound this with the other sensitivity check proposed by Chetty et al.: price deflators. Using the well-known bias in the the CPI that overestimates inflation by 0.8%, Chetty et al. find that, by the end of their perod, there is roughly a ten percentage point difference between the baseline uncorrected CPI and the corrected CPI (see below). Compound this with the corrections for family and you still get a decline – but again the slope of the decline is much more modest. If you add panel B from figure 3 in Chetty et al – which includes taxes and transfers – you probably get a few extra points up. There will still probably be a decline, but a moderate one.

pricetaxes

Finally, at footnote 19, Chetty et al. also point out that they do not account for in-kind transfers prior to 1967 (there were some).  And, on page 13, they point out that “one may be concerned that levels of absolute mobility for recent cohorts may still be understated because of increases in fringe benefits, nonmarket goods, or under-reporting of income in the CPS”. Add in all these little extra problems to the family size, the transfers and the inflation correction and I am not sure how big the drop from 1940 to the end of the studied period is. Finally, I would also add that an understudied point in economic history is what the distribution of in-kind payments according to income was. From studying the British industrial revolution, I have generally to see that it is the poorest workers who receive in-kind payments (which are not measured) and the richest receive much fewer of those in proportion of their incomes. One of the few to note that distributional was the hardcore left-leaning scholar Gabriel Kolko who mentioned this issue in Dissent back in the 1950s.  If Kolko is correct, then the income of “poor parents” in 1940 is underestimated. As a result, the bar over which the children of said parents must jump is set mildly too low. If that is the case, the odds for the 1940 birth cohort are overestimated.

Combine all of these things together and I am not sure that the drop is as dramatic as many are making it out to be. I would be very satisfied if Chetty et al. would publish all the corrections they did and do a sensitivity check with hypothetical regarding a sliding-scale of in-kind payments in 1940 according to income (10% of income for poorest to 0% for the richest). I would just like to see how much it matters.

Inherited wealth and size of government

Vincent Geloso Economics, Liberty , ,

In the debate over inequality, I have long argued that governments are much better at creating inequality than at reducing them (see my paper here with Steve Horwitz). Through rent-seeking and regulatory capture, interest groups manage to redistribute wealth in the “wrong” direction. There are a great many cases of large fortunes amassed thanks to government favors (think of the Bombardier family in Canada or Carlos Slim in Mexico).

Yet, as many scholars have pointed out, large fortunes can be rapidly consumed by squabbling heirs and poor investments (see this paper here notably). Thus, the fortunes gathered by parents who earned government favors can melt away over time. Nonetheless, governments do protect the fortunes of the heirs if they continue in business. For example, the heirs of the Bombardier family in Canada continued their ancestor’s work and remained relatively well-off. This is in part because governments continue to rescue that firm from its misfortunes. In a way, government may act to limit the erosion of fortunes. We can phrase this differently by asking whether or not the size of government is correlated with the share of wealth from the “ultra-rich” that is gained through inheritance.

Using a working paper from the Peterson Institute for International Economics titled The Origins of the Superrich: The Billionaire Characteristics Database authored by Caroline Freund and Sarah Oliver and the Economic Freedom Index of the World produced by the Fraser Institute (released this week), we can check for the existence of this correlation. The paper by Freund and Oliver documents the share of the total wealth of billionaires that was earned through inheritance.

Unsurprisingly (for me), the lower the index for the size of government, the greater the share of wealth earned through inheritance. Using all OECD and European countries, we can very well see that the size of government is negatively correlated with the share of wealth from inheritance. untitled

Maybe, just maybe, those who believe that the solution to rising inequality is more government redistribution should be willing to reconsider their proposed cure. This is, I believe, an additional cause for skepticism regarding remedies.

Libertarians and Pragmatists on Democracy Part 4: Why Market Anarchism is more Democratic than Democracy

Zachary Woodman Economics, Law, Liberty, Philosophy , , , , , , , , , , , , , ,

Note: This is the final part of a series on democracy. It is assumed the reader is familiar with part one, defining democracy, part two, summarizing classical liberal perspectives on democracy, and part three, which analyzes how pragmatists conceive of democracy as a broader philosophy. Here, I will argue that a synthesis of libertarian and pragmatist perspectives on democracy will yield an argument in favor of market anarchy.

The insights of classical liberalism, and particularly modern libertarianism, have shown that democracy is likely to lead to a tyranny of an irrational and ignorant majority and public choice theory has shown how it results in awful policies thanks to a number of collective action issues. However, as pragmatists have argued, democracy’s philosophical aspirations to scientific public deliberation, seeking the consent of the governed, valuing the dignity of every individual, and decentralizing political authority to take advantage of dispersed intelligence are still admirable. However admirable these philosophical aspirations are, real-world democracies completely fail to fulfill them.

The natural question is, if not democracy, what political arrangements can live up to the philosophical goals of Dewey and Hook? I think the answer lies in market anarchism. In what follows, I will show how market anarchism could succeed in realizing the aspirations of philosophical democracy where political democracy has failed.

Before we get started, let’s take into account a few minor housekeeping notes. It is assumed that the reader has at least a cursory knowledge of how market anarchism and polycentric law works. If you are not familiar with these concepts I highly recommend watching this video by David Friedman before continuing. Also, I am in no way arguing that any of the thinkers discussed in this series are “really” anarchists unless they’re obviously so such as Huemer. I will not even claim that any of them “should have been” anarchists (with the exception of Hayek). I am simply arguing that if we take into account the insights of their various perspectives, one could plausibly defend market anarchism.

Market Anarchism, Unlike Democracy, Does Rest on the Voluntary Consent of the Governed

As Michael Huemer convincingly has shown, democracy does not actually “rest upon the freely given consent of the governed” as Sidney Hook claims. The bar tab example illustrates that we would not consider majority rule “consent” in any everyday interaction and there is little reason to think it should be any different in the context of political institutions. By contrast, market anarchism is almost by definition based off of consent. This is the primary reason why many deontological market anarchists, such as Murray Rothbard, are market anarchists in the first place and why they oppose the coercive, non-consensual nature of the state. While democracy’s claim to legitimacy is that the governed vote but they are still forced to follow the (unjustified) authority of a state that has the monopoly on force whether they agree or not to, market anarchism is based off of voluntarily consented to contracts between individuals and defense agencies and contracts between those defense agencies and private, voluntary court systems and arbitrators. Further, the content of the laws is agreed to and law becomes a product one buys in voluntarily agreeing to sign up with a defense company, just as one buys a car, a piece of furniture, or any other good.

It is curious that many pragmatist defenses of democracy sound very similar to what many market anarchists and libertarians write. Not just in Sidney Hook’s definition of a democracy as a government that “rests upon the freely given consent of the governed,” but perhaps most strikingly in John Dewey’s 1939 essay “I Believe.” In this essay, Dewey walked back some of his early Hegelian collectivist lines of his early years:

My contribution to the first series of essays in Living Philosophies put forward the idea of faith in the possibilities of experience at the heart of my own philosophy. In the course of that contribution, I said, “Individuals will always be the center and the consummation of experience, but what the individual actually is in his life-experience depends upon the nature and movement of associated life.” I have not changed my faith in experience nor my belief that individuality is its center and consummation. But there has been a change in emphasis. I should now wish to emphasize more than I formerly did that individuals are the final decisive factors of the nature and movement of associated life.

Indeed, throughout the whole essay he emphasizes “the idea that only the voluntary initiative and voluntary cooperation of individuals can produce social institutions that will protect the liberties necessary for achieving development of genuine individuality.” Throughout the essay, he decries (like many left-anarchists do) “state socialism” just as much as he does “state capitalism.” Dewey’s opposition to capitalism is well-known, but what is less known is his opposition to so-called “public collectivism.” His criticisms here could just as easily have been written by someone like Hayek:

Recent events have shown that state socialism or public collectivism leads to suppression of everything that individuality stands for. It is not too late for us in this country to learn the lesson taught by these two great historic movements [ie., the rise of state capitalism and state socialism]. The way is open for a movement which will provide the fullest opportunity for cooperative voluntary endeavor. In this movement, political activity will have a part, but a subordinate one. It will be confined to providing the conditions, both negative and positive, that favor the voluntary activity of individuals.

It is interesting that, like anarchists who favor direct action, he emphasizes that political activity is subordinate to the political movement he sees as necessary.

Of course, there are still notable differences between Dewey and libertarians, he still defends what he calls “functional socialism” in the socialization of medicine and still berates more than many libertarians would be comfortable with (except, of course, for left-anarchists) inequality caused by state capitalism. His vision of a truly individualist society, even in his later years, was one with localized, experimental democratic institutions and economics controlled by those localized governments in a “functional socialist” fashion (as I mentioned earlier, that economic vision is at odds with Dewey’s epistemological commitments).

However, I would argue that it is more than a mere superficial coincidence that Dewey’s criticisms of state capitalism are almost identical to those of market anarchists who decry “crony capitalism,” that his criticisms of state socialism are very similar to some individualist libertarian criticisms, and his overall rhetoric defending democracy on the grounds of “voluntary cooperation of individuals” sounds remarkably similar to many libertarians. This is because, largely, the philosophical ends Dewey seeks in politics are the same as those sought by libertarians, market anarchists, and classical liberals. However, the institutional means he advocates are very different and fail to meet those ends.

There is, conversely, one potential criticism that Sidney Hook would raise at this point: that market anarchism does not really rest upon the freely-given consent of the governed due to its allowance for economic inequality. Hook argued that income inequality undermines consent in democracy and, as a result, economic organization should be controlled by a democratically elected government. There are two points to be made. First of all, when economic organization is controlled by government in democracies it exacerbates the problem of income inequality. Rent-seeking culture arises in which concentrated interests use, through lobbying power, government force to accumulate and protect their wealth. Indeed, as I mentioned earlier,  there have been empirical studies showing how over-regulation lobbied for by those concentrated benefits have regressive effects. Even fairly anti-free market economists such as Joseph Stiglitz have argued that income inequality is not an inevitable result of market institutions, but a result of bad government policies such as corporate welfare.

Second, it is questionable to what degree income inequality would exist in pure market anarchy. Of course, much of the bad inequality experienced under state capitalism is the result of bad policies, but some if it is also just a result of market’s tendencies to disrupt economic distributions (which, as Mises argued in Liberalism: The Classical Tradition is not a bad thing because it allows for luxury markets which can serve as an experimental market for expensive, new goods that one day become popular consumer goods). Some market anarchists, such as Anna Morgenstern, have argued that the type of mass accumulation of capital under capitalism would be impossible under market anarchism. I am unsure to what extent I agree, and a systemic analysis of the economic roots of inequality is outside of the scope of this post. However, suffice it to say that it is an open, empirical question whether purely free markets would result in problematic levels of inequality, as Hook seems to think, and we have some good reasons to think it would not. At the very least, it is clear that the democratic institutions favored by Hook are not a serious solution to the problem.

Market Anarchism, Unlike Democracy, Relies on a Decentralized Process of Political Decision Making

Dewey argued in “Democracy and Educational Administration” that “it is the democratic faith that [the distribution of knowledge and intelligence] is sufficiently general so that each individual has something to contribute and value of each contribution can be assessed only as it enters into the final pooled intelligence constituted by the contributions of all.” He seems to echo Hayek’s knowledge problem critique of socialism when he argues that the democratic faith is based on the wisdom that “no man or limited set of men is [sic] wise enough or good enough to rule others without their consent[.]” As we have seen, democracies tend towards heavily centralized governments that undermine this faith and fail to take advantage of the dispersed knowledge (in Hayekian terms) among individuals in society.

Market anarchy, on the other hand, by definition takes advantage of this feature of dispersed intelligence. Rather than having law be designed by a centralized legislature, law arises out of voluntary market exchanges between individuals and, like common law, the precedent of judges in private courts. Of course, both Dewey and Hayek embraced democratic institutions (in Hayek’s case, as well as free market economic coordination) to take advantage of decentralized knowledge. However, both Dewey and Hayek, particularly the ladder (Dewey never wrote about market anarchism as it did not exist as a unique perspective until almost a decade after his death), failed to appreciate the extent to which a polycentric legal system does this much better. Peter Stringham and Todd Zywicki have noted this tension in Hayek’s thought in particular, as they put it in an abstract for their excellent paper on the issue:

Should law be provided centrally by the state or by some other means? Even relatively staunch advocates of competition such as Friedrich Hayek believe that the state must provide law centrally. This article asks whether Hayek’s theories about competition and the use of knowledge in society should lead one to support centrally provided law enforcement or competition in law. In writing about economics, Hayek famously described the competitive process of the market as a “discovery process.” In writing about law, Hayek coincidentally referred to the role of the judge under the common law as “discovering” the law in the expectations and conventions of people in a given society. We argue that this consistent usage was more than a mere semantic coincidence — that the two concepts of discovery are remarkably similar in Hayek’s thought and that his idea of economic discovery influenced his later ideas about legal discovery. Moreover, once this conceptual similarity is recognized, certain conclusions logically follow: namely, that just as economic discovery requires the competitive process of the market to provide information and feedback to correct errors, competition in the provision of legal services is essential to the judicial discovery in law. In fact, the English common law, from which Hayek drew his model of legal discovery, was itself a model of polycentric and competing sources of law throughout much of its history. We conclude that for the same reasons that made Hayek a champion of market competition over central planning of the economy, he should have also supported competition in legal services over monopolistic provision by the state — in short, Hayek should have been an anarchist.

There is one possibly fatal objection to this line of reasoning, that is also the most substantial objection to market anarchism as a whole: the possibility that market anarchy, like democracy, will eventually lead to a centralized state that undermines its attempt to take advantage of dispersed knowledge. This argument was initially hinted at by Robert Nozick in Anarchy, State, and Utopia in his argument about the “immaculate conception of the state” but was expanded on most convincingly by Tyler Cowen. Ultimately it is an empirical question whether market anarchy would eventually lead to more centralization, and it is outside the scope of this post to analyze that fascinating question in any satisfactory amount of detail. I will say, however, that Bryan Caplan has given more or less convincing reasons why this may not be the case.

Market Anarchism, Unlike Democracy, Values the Dignity of the Individual

One of the features central to the pragmatist “democratic faith” is the belief that “belief that every individual should be regarded as possessing intrinsic worth or dignity[.]” As I argued, the conflation of democratic governments with the “collective will” of the people undermines this faith as political dissenters and individual thinkers become viewed as opponents to “the people.” Indeed, it seems that the type of “public” and “private” collectivisms that Dewey ridiculed in “I Believe” are a result of democratic institutions run amuck.

Market anarchism, meanwhile, suffers from no such issues. Instead, the intrinsic worth of the individual is respected as their free choices and associations is the main driving mechanism for political organization. There is no violation of free speech and free thought by a deliberative government as such a government does not exist in the first place under anarchy, and thus the intrinsic worth and dignity are not found in the “will of the people” as in democracies, but in the sovereign individual’s choice of which defense provider to contract with.

Market Anarchism, Unlike Anarchy, is Scientific and Deliberative

Contrary to Dewey and Hook’s characterization of democracy as a deliberative, intelligent application of the scientific method to social issues, democracy is instead characterized by polarizing populist pandering and rationally ignorant and irrational voters casting meaningless ballots based cultural associations rather than reasoned consideration of policy issues. Market anarchism, meanwhile, does have the deliberative, scientific nature the pragmatists vainly hope democratic institutions could aspire to. While under democracy the cost of casting an informed vote is very high and the benefits very low resulting in massive amounts of rational ignorance, under market anarchism individuals have every incentive to ensure they are informed about the legal rules they are purchasing, so to speak, by contracting with rights defense agencies. Unlike in democracy where the benefits of casting an informed vote are extremely low because your vote has an infinitely small probability of making a difference, under market anarchy the rights defense agency you chose to contract with has immediate and certain impacts upon your life, thus creating a much larger incentive to cast an informed (metaphorical) vote by choosing to purchase the services of a preferred rights defense agency.

Deliberation about legal policy is far more likely to be more reasoned in market anarchy than in democracy. First, because market anarchism is more radically experimental than political democracy. Freedom of speech and of thought in democracy is often likened to a metaphorical “marketplace of ideas,” but in market anarchy it is a literal marketplace in which the ideas are not chosen just by speculation and public deliberation, but actually experimented with and acted upon in practice. Democracy is only “experimental” in a priori public deliberation about policies, but market anarchy is “experimental” in actually applying those policies and assessing their results a posteriori. Under democracy, once a policy is chosen it becomes difficult to assess counterfactually if another potential policy could have yielded better results, thus it is difficult to ascertain which was the superior policy. It is as if scientists in a lab simply talked about the hypothetical results of various hypothetical experiments and chose theories based on their discussions rather than actually testing the theories by actually running the experiments. Because of the polycentric nature of law under market anarchy, multiple policies are taken on at the same time, making it easier to tell which is more desirable in practice rather than simple theoretical deliberation.

Another reason why political deliberation is more likely to be reasoned in market anarchy than democracy is because of the institutional mechanisms for choosing policy. The main way law is “made” in democracy is through legislation voted on by representatives, who are ultimately accountable to the public through general elections. Often, debate on the floor of legislative bodies is anything but reasoned and deliberative, and clearly discussion about elections quickly devolves into mindless partisan bickering, sensationalist “scandals,” and populist rhetorical flair rather than reasoned discussion about policies. In market anarchy, however, law is “discovered” by private arbitrators and judges who are ultimately accountable to the defense firm’s consumers in the marketplace. It is pretty clear that real-world courtrooms tend to have a more elevated level of dialogue than legislative bodies, to say less of public elections, and I fail to see why this would not be the case under market anarchism.

Further, there wouldn’t be a need for partisan bickering and debates that bring down the level of public discourse in market anarchy, for similar reasons why there isn’t nearly as nasty debates about preferences for consumer goods as there are about politics. To use an analogy, in democracy, if we’re voting on what soda to consume, whoever wins the vote gets a monopoly on their preferred soda; so my preference for Coke could possibly eliminate your ability to enjoy Pepsi; but in a market, if I prefer Coke you still can drink Pepsi, meaning we don’t need to bicker about our consumer preferences. It is similar (though clearly not identical because when we’re talking about law it’s quite a bit more consequential) with legal policies: in democracy, if I prefer one set of legal rules to another which you prefer, we must fight over how to vote because the two are mutually exclusive; but in market anarchy, because law is polycentric and not monolithic, they are not mutually exclusive so we don’t need to fight nearly as hard for it. There’s a good reason why debates among consumers for products they prefer (Coke v. Pepsi, Apple v. Windows, Android v. iPhone) rarely get as nasty as debates in democratic politics, because there is room for disagreement at the end of the day in a market that there is not in politics.

Conclusion

Clearly, democracy is far from the ideal method of political organization. As classical liberals throughout history have shown, despite the fact that it may be possible to other political forms such as oligarchy and monarchy, it has a tendency towards the tyranny of the majority and massive collective action problems. However, the philosophical aspirations of the most ardent defenders of democracy are still extremely valuable, even if their preferred institutions fail to deliver. Market anarchism is a reasonable synthesis of these two insights; it has the potential to live up to the aspirations of pragmatist democrats without the major, systemic problems of real working democracies that undermine those aspirations.

John Dewey once said “democratic institutions are no guarantee for the existence no guarantee for the existence of democratic individuals,” what is needed is a better set of institutions that have a higher probability to cultivate Dewey’s idea of “democratic individuals.” Market anarchism appears to be a viable candidate for such a set of institutions.