Inequality III: Tyler Cowen's strange silence

UPDATE: Forget everything I've written here. Stephen Gordon says taxing the rich is no use.

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OK, I’ve had another look at Tyler Cowen’s AI essay on inequality, and the more I think about it, the more annoyed I am by it.

To recap: What I found initially so intriguing about his argument is that he doesn’t  worry about the effects of income inequality. He dismisses most of it as mere envy, which he sees as for the most part a “local” phenomenon.

So instead, what he does is flip the argument upside down. What we should worry about, he argues, is the dynamic that is causing increased inequality. As he sees it, a substantial amount of the rise in inequality is due to the functioning of the financial markets, in particular the strategy of "going short on volatility". This allows bankers to rack up huge private profits in normal times, and then socialize all the losses during abnormal (crash) times.

As Cowen himself concedes, this has a large number of serious and highly negative public effects.

1. The outsized gains in the sector attract a disproportionate share of society’s smartest and most hardworking individuals. This “represents a huge human capital opportunity cost to society and the economy at large”.

2. The correlated nature of the risk means that when the bets go wrong, everyone pays the price. In particular, it puts a huge number of people out of work.

3. The bailout transfers money from “the Treasury to the major banks”, i.e. from taxpayers to the people who caused the problem.

4. It constrains productivity by preventing huge amounts of capital from being put to any productive use.

Inequality is simply an effect of the banking and financial sectors learning to game the system. These are very, very serious effects, which even Cowen himself concedes. So what to do about it? Cowen thinks the answer is, “not much”, and he goes so far as to suggest that this is “simply the price of modern society.”

This is obscene. When you boil it down, all Cowen has done is repeat many of the arguments that were accepted by mainstream economists years ago: Excessive inequality is wrong because it is inefficient. It results in a colossal misallocation of human capital, of the public treasury, and of private wealth. And keep in mind – these are Cowen’s points, not mine.

The only way, then, Cowen’s quietism can be justified is if the banking and finance sector provided such a vital public service that the public benefits outweigh the costs of the occasional crash. But there is no evidence that is the case. Even Cowen doesn’t try to make that case – as he puts it, these people aren’t providing a vital service, they are “gaming the system”.

Why on earth would we then simply accept it as the price of “modern society”? Maybe it is true, that we don’t have the ability to properly regulate the industry, and that any attempt to do so will backfire or result in perverse consequences. So be it. But that doesn’t mean that we have to just suck it up. After all, those outsized gains exist, they are sitting there in bank accounts, and in the form of Jags and houses in the Hamptons and Damien Hirsts and all other perks of being a Wall Street big shot.

And keep in mind, again, that these gains are, ex hypothesi, illegitimate. That is, by Cowen’s own analysis, these are windfall profits earned by gaming the system and which play no productive role in the economy.

So while we might not be able to regulate the industry so as to prevent this money from being acquired, there is another mechanism at the state’s disposal. It’s called the tax system. Tax something and you get less of it, economists like to say. Well, one of the most influential popular economists in North America is concerned that there are too many people going into finance, concerned that these people are earning too much money, and concerned that the public fallout from their activies is too great. We want less of all of this? Tax the hell out of it at every stage. Tax the business schools that train these people. Tax the incomes on the earnings. If that's too hard, tax their expenditures on the Jags and the homes and the Hirsts.

As it turns out, this is exactly the solution to rising inequality proposed by the economist Robert Frank: A massive and steeply progressive luxury tax that returns these outsized gains to the public treasury. At the very least, that money can then be used to fund an extremely generous employment insurance fund for workers who lose their jobs during crises caused by the operations of the financial sector. Instead of the state bailing out the people who caused the crisis, the people who caused the crisis would be bailing out the people they have harmed.

Tyler Cowen has argued against this solution in the past. Given his new analysis of income inequality, I don’t see how he can continue to resist it.