Sunday, September 28, 2003

The turning point?

When I first read pre-insanity Krugman's "Unequal Exchange" essay (1998) it made no sense to me. But I shrugged and moved on, because in general Krugman was so worth listening to. But his obsession with the wealth inequality between the top 0.01% and 1% has now reached such fevered heights it's best to ignore him and go back to his older, lucid pieces.

On re-reading "Unequal Exchanging" it seems that this may be where Krugman went off the deep end. He uses an analogy to model two economies and state a preference for redistribution based on those models:
[C]onsider this simple parable : there are two societies. In one everyone makes a living at some occupation-say, fishing-in which the amount people earn over the course of the year is fairly closely determined by their skill and effort. Incomes will not be equal in this society-some people are better at fishing than others, some people are willing to work harder than others, but the range of incomes will not be that wide. And there will be a sense that those who catch a lot of fish have earned their success.

In the other society, the main source of income is gold prospecting. A few find rich mother lodes and become wealthy. Others find smaller deposits, and many find themselves working very hard for very little reward. The result will be a very unequal distribution of income. Some of this will reflect effort and skill: those who are especially alert to signs of gold, or willing to put in longer hours prospecting, will on average do better than those who are not . But there will be many skilled, industrious prospectors who do not get rich and a few who become immensely so .

Surely the great majority of Americans , no matter how conservative, instinctively feel that a nation that resembles the second imaginary society is a worse place than one that resembles the first. It is also no question that our nation today is much less like the benign society of fishermen-and much more like the harsh society of prospectors-than it was a generation ago.
Krugman argues that income redistribution in a gold mining economy is "better" than in a fishing economy because the outcomes of gold prospecting are more based on luck than skill. While I sympathize with the sentiment, I would expect better logic from a first year econ undergrad. If you want people to take on risky behavior, you need to offer them greater rewards (or, if there is greater variance in expected outcomes, the expected outcome must be higher to elicit the same effort). In other words, the more risky the behavior is (or the more luck based the outcome is), the higher the rewards needs to be to compensate for the greater risk. This argues for less redistribution because taxing wins in a high-risk environment reduces effort by a far more dramatic amount than taxing wins in a low-risk environment. A winner-take-all economy, harsh as it may be, needs lower redistribution for efficiency, not higher.

The other point is that if economies go from "fishing" to "gold mining", it is because of technological change, not because of any policy. Whether or not you can fish depends on if you're close to the sea. The two economic arenas I can think of that might work like gold mining are fashion industries (driven by hits) and technology industries with large demand side positive externalities (software like Microsoft Windows). But large swathes of the economy do not remotely resemble either of these. I'm not sure if Krugman would want the government to intervene to direct technological development (once I would have assumed "no way" but now, who knows?) but throwing sand in the gears of where technology is taking us whether we like it or not seems, well, positively conservative.


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