Noah Smith has a new piece in The Atlantic today about wealth distribution (yes, it has to do with that dumb video). The refreshing part is, Noah’s article isn’t pure nonsense. I would hope not, of course, being as Noah is a finance professor at SUNY Stonybrook.
The thrust of Noah’s argument is that in the short run wealth is determined by endowment/income; in the long run, wealth is determined by time preference/interest rate. I don’t think I’ve ever heard that odd theory before, certainly not in the news media…but let’s run with it!* Here’s Noah:
So one obvious thing we could do to make wealth more equal is – surprise! – redistribution. It turns out that income redistribution and wealth redistribution have much the same effect on the wealth of the poor and middle-class. Income redistribution is probably a bit better, for two reasons. First, people with higher incomes tend to save more, meaning they build wealth more rapidly. Second, people with higher incomes tend to have less risk aversion, meaning they are more willing to invest in assets like stocks (which get high average rates of return, although they are risky) rather than safe assets like savings accounts and CDs that get low rates of return.
In other words, giving the poor and middle-class more income will boost the amount they are able to save, the percentage they are willing to save, and the return they get on those savings. Part of the reason America’s wealth distribution is so unequal in the first place is that our income distribution is very unequal.
I have a couple nits to pick here. First, income and wealth redistribution are the same thing, unless you’re talking about legally changing the ownership of real and nominal assets (i.e. houses or stocks). People don’t send iron from their yacht or bricks from their house to pay wealth taxes, they send dollars from their income stream. Taxing wealth is taxing income. Income taxes are bad enough without double and triple taxing income. Not to mention, in the long run, “wealth taxes” are paid by labor through lower income.
Second: Noah implies in the paragraphs above that the poor don’t save because they are income constrained…but it is equally, if not more likely that people are income constrained because they have an inability to save. Or to put it more technically, poverty is a symptom of a lack of skills combined with peoples’ inability to overcome humans’ natural tendency toward hyperbolic discounting. That is, there is an identification problem. There are plenty of “middle class” (NOT AN INCOME GROUP) people for whom the second part is true, as well. Simply redistributing income will, indeed, boost the amount that poor and middle class people are able to save. There is a big question mark as to how much they will be willing to save. Evidence from endowments (i.e. the lottery, oil wealth on Native American land) tend to pour cold water on Noah’s line of causation. It is, again, equally as likely that people will ratchet up their consumption as their income increases.
Noah’s last sentence is refuted by the fact that Denmark has the highest measured wealth inequality according to the video’s own data.
Here are Noah’s proposed solutions:
Instead, the answer is to change America’s culture of (not) saving. This sounds hard, but actually it is probably very doable. For years, behavioral economists such as Richard Thaler have been studying ways to “nudge” people to save more. The most famous “nudge,” which has been endorsed by President Obama, is to make employee pension plans “opt-out” instead of “opt-in”. But there are plenty of others. In lab experiments, just giving people information on how to save money makes them save a lot more.
This means that more financial education in public schools is a must. I’m not talking about teaching kids the Capital Asset Pricing Model. I mean what Bob Shiller calls “basic Suze Orman stuff.” How to make a monthly budget. What “saving” and “borrowing” mean. How wealth builds over time. How to avoid borrowing lots of money at high interest rates (e.g. credit cards and payday loans). Etc. The new Consumer Financial Protection Bureau can help a lot with this too, by preventing companies from tricking poor people into taking out high-interest debt.
I don’t have a lot of problem with Richard Thaler’s idea of altering choice architecture in a way that makes saving the default option…the problem is the very people for whom Noah is most concerned are the people who don’t have access to financial services such as 401(k)’s. This is a big problem for his idea…and the only solution is extremely paternal, all the way up to mandating savings. Noah may not have a problem with that, and I could be persuaded as well (it is Singapore’s model, btw), but it would take a lot.
The second paragraph runs into
all sorts of a big problem. First and foremost, just as sure as the hard-line right’s canned idea to poverty is to have the poor reap the fruits of their folly (an idea that has a line of tradition stemming from Malthus and Benjamin Franklin), the left’s idea is “more education”. It is literally a canned response. However, both of these “solutions” suffer from the same problem: they exaggerate the problem, which is that people find it hard to forego small short-term gains for (even) exponentially larger long-term gains. Lower income students are the very students who are most at risk for dropping out of school. The left’s idea of making sure that people understand exactly how they’re screwing up is just as emotionally taxing as kicking someone when they are down. People don’t “avoid” or “not avoid” high interest financial products because they have an option, oftentimes that is the only option. That is part of what the literature on how expensive it is to be poor is all about.
I may sound like I’m being pretty hard on Noah, but I actually think his article is a step above what we’ve been hearing, and I appreciate that it has some logical rigor behind it. I think Noah is nearing correct conclusions, but is clouded by some ideas that (while good-intentioned), have been around for a long time, and haven’t proven all that fruitful. In a subsequent post (and my last post relating to the video referenced above), perhaps later tonight, I will lay out a sketch of my ideas of how to boost intergenerational wealth accumulation among lower and (to a lesser extend) middle income people.
*This sentence was a joke.