Inequality, Updated

There are a number of ways to tackle the problem of growing income inequality. For those who think it is no big deal, one way is to simply deny the phenomenon. Another, more intellectually responsible approach, is to accept that it exists, but offer arguments for why the inequality is not as big a problem as many on the left make it out to be. That's Will Wilkinson's approach in his recent essay for the Cato institute.

From those who take inequality seriously, some on the far left tend to look at ways of eliminating the phenomenon, usually by taxing the living heck out of big earners and redistributing it. Others focus on the effects of rising income inequality, and, where those effects are judged pernicious, suggest ways of mitigating them. That's my basic approach in my essay in the latest issue of Canadian Business.

In an essay in the latest issue of The American Interest, Tyler Cowen offers one of the most original analyses I've seen about inequality. What he does is flip the argument upside down, arguing that the effects of income inequality are not that big of a deal. What we should worry about, he argues, is the dynamic that is causing it. As he sees it, rising inequality is almost entirely due to the functioning of the financial markets, in particular the strategy of "going short on volatility". This allows bankers to rack up profits in normal times, and then socialize all the losses during abnormal (crash) times.

The upshot of all this for our purposes is that the “going short on volatility” strategy increases income inequality. In normal years the financial sector is flush with cash and high earnings. In implosion years a lot of the losses are borne by other sectors of society. In other words, financial crisis begets income inequality.

Worse, it isn't clear what to do about it:

For the time being, we need to accept the possibility that the financial sector has learned how to game the American (and UK-based) system of state capitalism. It’s no longer obvious that the system is stable at a macro level, and extreme income inequality at the top has been one result of that imbalance. Income inequality is a symptom, however, rather than a cause of the real problem. The root cause of income inequality, viewed in the most general terms, is extreme human ingenuity, albeit of a perverse kind. That is why it is so hard to control.

Cowen goes on to suggest that this might just be the price we pay for a modern economy. The unanswered question, I think, is whether the macroinstability of this system in the financial realm translates into instability in the political realm. Cowen doesn't appear to take political instability seriously, largely because he seems to think that Americans are generally ok with the system they see. But -- and this is the one point in my CB essay that I think bears on this issue -- that might be because Americans severely underestimate the extent of inequality,  are deluded as to the true amount of social mobility, in their country.