Friday, March 28, 2014

Interfluidity on the Consequences of Inequality for Incentives and My Thoughts

We should expect the prevalence of rent capture (or worse) as a source of economic profit to increase with technological progress. Why? Because, absent chicanery, technology increases the ease of production and the efficiency of distribution. As Schumpeter pointed out, the source of profit in real-life capitalism is the fact that monopoly power is ubiquitous because of natural barriers to competition. The corner store has a monopoly on the convenience of its neighbors, and so can capture some of the surplus that might otherwise be bid away to customers by competitors. On-demand delivery drones would eliminate that monopoly. Yet the corner store industry might lobby to prevent residential rooftop deliveries, in which case it is no longer exploiting a natural inefficiency but capturing a rent. In business school, students are taught that a successful business has a “moat” that makes it difficult for competitors to bid away ones margins. Technological progress renders moats that derive from nature harder to come by. Instead, successful businesses — and successful people (since under capitalism, a human is just a small business) — must rely increasingly on moats that result from social and political arrangements...
“Inequality” — high dispersion of outcome — creates a strong incentives to be on the side of winners. There are some circumstances where being on the side of winners means making an outsize contribution to economic production. There are other circumstances where winning means aligning oneself with coalitions capable of winning legal and political contests that may be orthogonal to, or much worse than orthogonal to, any contribution to production. The two strategies don’t preclude one another...
Instead of talking about “incentives to” (produce, extract rents, whatever), we might describe outcome dispersion as a tax on refraining from mercenary behavior. If the difference between economic winners and losers is modest, people of ordinary virtue might refrain from participating in activities they consider corrupt, might even be willing to “blow the whistle”, because the cost of doing so is outweighed by their preference for behaving well. But as outcome dispersion grows, absenting oneself from or even opposing activities that would be personally remunerative but socially undesirable becomes too costly.

Full post here

If this line of thinking is right, in a world with enough inequality, technological progress will have two counteractive effects on growth. It will of course tend to push up real wealth production by improving productivity. However, it will also tend to reduce output by diverting activity away from production and towards the artificial maintenance of the displaced natural rents. The question becomes, how long can this process last?

It is hard to say. Obviously, if technological progress increases productivity faster than it diverts productive activity, the process could continue more or less indefinitely. A smaller and smaller fraction of society would work to produce the goods and services society uses. While everyone else worked to maintain the social arrangements that enabled that. The total size of the 'pie' would increase fast enough that everyone is still better off in absolute terms (even if inequality increases), so no one has a strong incentive to complain.

If the increase in productivity does not outpace the diversion of resources from productive activity, the picture becomes more complicated. As before, fewer and fewer people work to produce what everyone consumes, but now there is not enough for everyone to be at least as well off as they were before. Especially if inequality is rising, some people start to see their material interests sacrificed. It could just as well be some of those people who are now working to maintain rents instead of the 'productive' workers; exactly who loses out is somewhat beside the point. This in turn leads to agitation by those who see their lives worsening, further diverting resources away from productive activity, as everyone else takes steps to protect themselves and their wealth. 

It is possible that the 'losers' are a sufficiently small and disorganized group, such that it is not particularly costly for everyone else to repress their agitation and the process to continue as normal. However, if this is not the case, then a destabilizing downward spiral could begin. The response to the serious threat posed by the recently disenfranchised proves too costly for everyone else to be protected, more people see their material conditions worsen (and are simultaneously forced to resort to increasingly difficult and drastic measures to protect what they still do have), swelling the ranks of the disaffected, forcing yet more and more costly protective measures and so on and so forth.

One can easily imagine all of this being rigorously constructed as a formal model, with intersecting lines and curves representing productivity, productive labor, rent seeking labor, the costs of protection et cetera. It would of course have a few different equilibria and a nice explanation of what factors might determine which equilibria the hypothetical society ends up at. Such a model would be pretty neat, but I do not know if it would do much for answering the most important question it would raise: exactly where on these curves are  we?

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