Last week I
wrote about the connection between income inequality and equality of
opportunity, indicating some disagreement with Friedman. This week I have
similar questions regarding Galbraith’s call for increased government spending,
especially in regards to its impact on innovation. For the most part, I tend to
agree with Galbraith. He raises some real concerns regarding why we doubt
government spending, and accurately identifies that large inequality can have
dramatic negative impact. I found his discussion of the ‘traditional’
underlying arguing justifying large inequality interesting: “The undisturbed
enjoyment of income was held to be an essential as an incentive. The resulting
effort and ingenuity would bring greater production and greater resulting rewards
for all…” or at least so says the conventional wisdom. While more egalitarian
policies “destroy ambition, penalizes success, discourages investment to create
new jobs, and may well turn a nation of risk-taking entrepreneurs into a nation
of softies…” Galbraith disagrees with much of this, calling for increased
social spending and more redistribution. However, he spends more of his time
discussing why, at the time of the writing, income inequality was a nonissue
(due to overall growth). It has clearly become a popular issue again, perhaps
because growth has stagnated for much of the population.
I thought Galbraith could have developed his argument here
more thoroughly. He gives a weak anecdotal evidence saying that businessman
claim to be working as hard as possible no matter what given policy is in
place. I wanted to know what sort of trade-off we were actually looking at in
terms of innovation if we were to implement “cuddly capitalism” policies:
truncated payoffs by increasing the safety nets by diminishing top payoffs.
Fortunately, a new paper
by Daron Acemoglu, James Robinson, and Thierry Verdier analyzes
just this subject.
Essentially,
the paper is countering an argument that the Scandinavian countries “cuddly”
redistributive policies are allowing the region to keep up similar growth
levels to the United States in a way the could be implemented in the United
States. The paper argues that cuddly capitalism only works if others are
cutthroat capitalists. Pulling from the above paper we see: “A greater
gap of incomes between successful and unsuccessful entrepreneurs (thus greater
inequality) increases entrepreneurial effort and hence a country’s contribution
to the world technology frontier. We show that, under plausible assumptions,
the world equilibrium is asymmetric: some countries will opt for a type of
“cutthroat” capitalism that generates greater inequality and more innovation
and will become the technology leaders, while others will free-ride on the
cutthroat incentives of the leaders and choose a more cuddly form of
capitalism.” It seems that there may be real costs to entrepreneurship and
innovation, as demonstrated by relative patents:
This paper
raises a number of interesting costs if the US converted to a more Scandinavian
style economic system (the type I think Galbraith is recommending). However,
other commentators have argued that pieces of the study don’t reflect reality.
For instance, Ezra Klein’s blog points out that the patent system in the United
States is being abused and skewing the numbers. Looking at relative change in
increasingly uneven income distribution, we see it does not have likewise
increases in patents.
This type of data raises questions about using patents as a
proxy for innovation. If instead we look at The World Economic
Forum’s Global Competitiveness Index,
we see a fairly different picture.
The data
does seem entirely conclusive in regards to the incentive. A priori, I find the argument mixed as well. Innovators may be more
likely to take more risks if they have a safety net to fall back on, but there
may also be a countervailing force: less incentive to work hard. Similarly,
capping the total gain from innovation through increased redistribution, should
on the margin decrease innovation. But given the large amount of money gained
from successful innovation, diminishing marginal utility of money may make this
actual decrease in incentive fairly minor.
The evidence does not seem to be entirely conclusive to me
in this manner. If we are to accept Galbraith’s argument that it is worthwhile
to redistribute in such a way, it is important to first understand what we give
up by doing so, something his book-and to some extent the modern literature-
does not answer satisfactorily.
http://lanekenworthy.net/2012/09/29/will-everyone-be-worse-off-if-the-united-states-turns-social-democratic/
http://economistsview.typepad.com/economistsview/2012/09/will-american-innovation-slow-if-we-go-cuddly.html
http://www.washingtonpost.com/blogs/ezra-klein/wp/2012/09/28/is-sweden-awesome-because-it-mooches-off-the-u-s/
Other sources included directly in the above post.
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