David R. Henderson  

Robert Frank's Confusions

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Cornell University economist Robert Frank has become the Johnny One Note of economics. His one note: how bad wealth and income inequality (he often doesn't distinguish between the two although he should) are, along with his particular reasoning about why we have such inequality. His reasoning? I'll get to that.

In "The Vicious Circle of Income Inequality," his latest piece in the New York Times, he plays that same note. Here goes. His thoughts are in boxes and my thoughts follow.

Almost every culture has some variation on the saying, "rags to rags in three generations." Whether it's "clogs to clogs" or "rice paddy to rice paddy," the message is essentially the same: Starting with nothing, the first generation builds a successful enterprise, which its profligate offspring then manage poorly, so that by the time the grandchildren take over, little value remains.

Much of society's wealth is created by new enterprises, so the apparent implication of this folk wisdom is that economic inequality should be self-limiting. And for most of the early history of industrial society, it was.


This is not an implication at all. Income inequality is a measure at a point in time. You could have rags to rags and, at the same time, high income inequality.
But no longer. Inequality in the United States has been increasing sharply for more than four decades and shows no signs of retreat. In varying degrees, it's been the same pattern in other countries.

You could easily have increased income inequality if the gains from innovation become higher and so innovators reap massive rewards. The measures of income inequality and wealth inequality rise. But their children squander it or, at least, if they have multiple children, dilute it. What Frank implicitly assumes is that the innovators and their children hold on to their wealth for generations. Maybe so, maybe no, but that has little to do with increased income inequality. Moreover, he has essentially pulled a bait and switch. The opening paragraphs, if not the title of his piece, cause the reader to think that Frank will discuss how "rags to rags" is no longer true. Later in the piece, he occasionally asserts it but he never establishes it.
The economy has been changing, and new forces are causing inequality to feed on itself.

One is that the higher incomes of top earners have been shifting consumer demand in favor of goods whose value stems from the talents of other top earners. Because the wealthy have just about every possession anyone might need, they tend to spend their extra income in pursuit of something special. And, often, what makes goods special today is that they're produced by people or organizations whose talents can't be duplicated easily.

Wealthy people don't choose just any architects, artists, lawyers, plastic surgeons, heart specialists or cosmetic dentists. They seek out the best, and the most expensive, practitioners in each category. The information revolution has greatly increased their ability to find those practitioners and transact with them. So as the rich get richer, the talented people they patronize get richer, too. Their spending, in turn, increases the incomes of other elite practitioners, and so on.


Could be. I don't know. On the other hand, how often do you hear high earners talking about what a great trip they had to India or China or Peru? If they did, they spent a large amount of money there and I'm willing to bet it wasn't mainly on services offered by other high earners: it was on services offered by relatively poor (relative to us) residents of those relatively poor countries.
More recently, rising inequality has had much impact on the political process. Greater income and wealth in the hands of top earners gives them greater access to legislators. And it confers more ability to influence public opinion through contributions to research organizations and political action committees. The results have included long-term reductions in income and estate taxes, as well as relaxed business regulation. Those changes, in turn, have caused further concentrations of income and wealth at the top, creating even more political influence.

Really? By recently, what time period does he mean? Blank out. So let's look at the most recent income tax legislation, enacted in early January 2013. Did Robert Frank notice how effective high earners were at protecting themselves from high tax rates? They weren't. Singles with income over $400,000 and married couples with income over $450,000 now pay a stiff marginal tax rate of 39.6 percent, up from 35 percent. Some influence. Or how about the Obamacare legislation of 2010? That legislation imposed a 3.8 percent tax rate on net investment income from dividends, interest, and capital gains for singles with a modified adjusted gross income (MAGI) of $200,000 and married couples with a MAGI of $250,000. This kicked in in January 2013. Many high-income people get income from dividends, interest, and capital gains. So the marginal income tax rate for many singles with income of $400,000 and many married couples with income of $450,000 rose in January 2013 from 35% to 43.4%. That's an increase of 24%. Stop those high-income people before they strike again.
I'll grant his point about estate taxes. Those have been reduced.
Relaxed business regulation? Really? Like Sarbanes-Oxley, EPA, Obamacare, Dodd-Frank?
By enabling the best performers in almost every arena to extend their reach, technology has also been a major driver of income inequality. The best athletes and musicians once entertained hundreds, sometimes thousands of people at one time, but they can now serve audiences of hundreds of millions. In other fields, it was once enough to be the best producer in a relatively small region. But because of falling transportation costs and trade barriers in the information economy, many fields are now dominated by only a handful of the best suppliers worldwide.

He's probably right here. But notice the implication. When technology enables the best musicians to serve hundreds of millions, costs fall. We consumers benefit. Is that just a detail to Professor Frank?
Income concentration has changed spending patterns in other ways that widen the income gap. The wealthy have been spending more on gifts, clothing, housing, celebrations and other things simply because they have more money. Their extra spending has shifted the frames of reference that shape demand by others just below them, so these less wealthy people have been spending more, and so on, all the way down the income ladder. But because incomes below the top have been stagnant, the resulting expenditure cascades have made it harder for middle- and low-income families to make ends meet. Despite taking on huge amounts of debt, they've been unable to keep pace with community standards. Interest payments impoverish them while enriching their wealthy creditors.

But if you change what you spend money on in order to keep up with the wealthy Joneses, who is responsible for that choice? I remember Frank, in one of his books or articles, talking about how incredibly fancy and expensive your purchase of a barbecue could get. He went out and bought, if I recall correctly, a barbecue priced at about $400. After reading that, I went to Costco and bought a much nicer barbecue than I had had--and paid $99.
But perhaps the most important new feedback loop shows up in higher education. Tighter budgets in middle-class families make it harder for them to afford the special tutors and other environmental advantages that help more affluent students win admission to elite universities. Financial aid helps alleviate these problems, but the children of affluent families graduate debt-free and move quickly into top-paying jobs, while the children of other families face lesser job prospects and heavy loads of student debt. All too often, the less affluent experience the miracle of compound interest in reverse.

True. But there's a solution: go to a community college for two years, earn your associate's degree, and then go to a state college for 2 years. If you're frugal and get a part-time job, you can get out with under $20,000 in debt. Again, it comes down to choices you make. Frank seems to want to blame the choices of person A on the example set by person B. But there's an old saying, probably the best thing your ever mother every taught you: If you see someone jumping off a cliff, should you jump off the cliff?
More than anything else, what's transformed the "rags to rags in three generations" story is the reduced importance of inherited wealth relative to other forms of inherited advantage. Monetary bequests are far more easily squandered than early childhood advantage and elite educational credentials.

He could be right. I don't know. But for more on how little Frank has thought through creative solutions to the education problem he poses, see this.
As Americans, we once pointed with pride to our country's high level of economic and social mobility, but we've now become one of the world's most rigidly stratified industrial democracies.

I don't know if we're one of the world's most rigidly stratified industrial democracies, but I can point to one of the main stratifiers: federal, state, and local governments that ruin people's lives by throwing them in prison for victimless crimes. Will Professor Frank join me in calling for an end to the drug war?
Given the grave threats to the social order that extreme inequality has posed in other countries, it's easy to see why the growing income gap is poised to become the signature political issue of 2014. Low- and middle-income Americans don't appear to be on the threshold of revolt. But the middle-class squeeze continues to tighten, and it would be imprudent to consider ourselves immune. So if growing inequality has become a self-reinforcing process, we'll want to think more creatively about public policies that might contain it.

It is easy to see, but Frank totally missed it. President Obama has made inequality and his attempt to go after "the rich" a signature theme in his 5 years in office. Also, with Obamacare doing badly, he wants to change the subject.
In the meantime, the proportion of our citizens who never make it out of rags will continue to grow.

Continue to grow? He hasn't even shown that it's grown. And he can't. That's because it hasn't grown. Standards of living for those in the bottom fifth have continued to rise just as they have for the other fifth.

Indeed, a way to see that is to take his "rags" metaphor literally and look at how people dress. When I was a kid in a middle-class home in the early 1960s, I had two pairs of pants. My father probably had four or five pairs of pants. Now a friend of mine who works in a cemetery and, with his wife's part-time income, has a family income putting them in the second-from-bottom fifth, has over 10 pairs of pants, 20 shirts, and 3 suits.

For more of my analyses of Robert Frank's views, see here and here.


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COMMENTS (20 to date)
David Friedman writes:

And for my long exchange with Bob Frank on my blog a few years back, see:

http://daviddfriedman.blogspot.com/search?q=Robert+Frank

Maniel writes:

David,
This is a fun topic. Inequality is now rampant, and I don’t just mean income inequality: victims should be taking up arms against height inequality (especially harmful in basketball, volleyball, homes with high shelves), strength inequality (physical work, football, shot-putting), age inequality (experience, earnings, athletic ability), appearance inequality (satisfaction in social encounters, interviews), location inequality (we’re sure having nice, dry weather here in San Diego), and much, much more. Naturally, none of these inequalities have anything to do with personal choices, hard work, or luck. We are all victims, oppressed by the wealthier, taller, stronger, older (or younger), better looking, better situated among us, and therefore there is no need for us to assume any personal responsibility in the matter.
Agree with high-income/wealth differentiation (which I believe supports the rags-riches-rags thesis). This was explained quite clearly by Waylon Jennings in Waymore’s Blues:

I got my name painted on my shirt
I ain't no ordinary dude, I don't have to work
I don't have to work.

David Friedman writes:

Unaccustomed as I am to defend Robert Frank, I think your final point is wrong--you are confusing levels with rates of change:

He wrote:
"In the meantime, the proportion of our citizens who never make it out of rags will continue to grow."

You respond:

"Continue to grow? He hasn't even shown that it's grown. And he can't. That's because it hasn't grown. Standards of living for those in the bottom fifth have continued to rise just as they have for the other fifth."

Suppose that, of the people born poor in 1950, 80% made it out of poverty, and of those born poor in 1980, 20% did. That's consistent with both his claim--the proportion of the poor who don't make it has risen from 20% to 80%, and the proportion of the population who don't make it has also risen (unless the proportion who are poor has fallen by at least a factor of four)—and yours.

Your argument is wrong for a second reason as well. Suppose the condition of the bottom fifth of the income distribution is staying exactly the same, decade after decade. The number who make it out of poverty could be going up, going down, or staying the same. In the extreme case, everyone who is poor in 1950 could be not-poor by 1980--with an entirely different set of people having fallen from not-poor to poor, leaving the condition of the bottom fifth unchanged.

I have no idea whether Robert Frank's claim is true or not, but it isn't a claim about what is happening to the real income of the bottom X% of society but about the upward mobility of the individuals who at a given time are in the bottom X%.

Mark V Anderson writes:

After reading the article by Frank, I understood why your posting was so long. There was so much to work with.

Frank takes a valid issue, that of inequality, and spends several paragraphs spinning half truths and irrelevancies about the subject. I am always amazed at the pablum respected journals like the New York Times accept as received wisdom. But aren't there any better discussions of inequality and possible ways for improvement from the Left out there? It makes more sense for each ideological side to argue with the best essays of the opposing side, not the worst.

David R. Henderson writes:

@David Friedman,
If I understand you correctly, I’m using the “rags” metaphor more literally than you. I use it to stand for a very low standard of living, not for being in the bottom fifth.

Joan Levine writes:

When Mr Hendersen refers to his and his father's pants collection and the good olde days (60s!) I am struck by the frame of reference. Mr Hendersen - Wake up and smell the coffee! We are not in the 60"s. Our children cannot compete with the privileged in this country and the GLOBAL competition coming at them from cultures whose children and their parents are desperate to get a toe hold on economic viability.

Did Hendersen compete with Chinese, Indian and other foreign young people to make his way?

Frank is talking about how it is NOW. And this isn't a sudden thing, it has been in the making for at least 20 years. Bush's weird tax deduction with his famous $500 rebate. What WAS that? No one even wanted it. No hue and cry and yet the congress let it happen. But the problem pre-dated that handout to the rich.

Now as Frank says, it's not just monetary advantage. It's educational opportunities, healthcare, nutrition. These impact the lives of children in a way that cannot be easily fixed with money later in the game. Policies have to be designed to give schools and children a chance to do the work they have to do to come up to speed for todays world.

Emil writes:

Joan Levine:

A) it seems to me as if it is Frank talking about how it is today in relation to how it was ("increasing income / wealth inequality")

B) no worries, the children of America will continue to have more pants than the average Chinese children for quite some time longer (don't confuse growth rates with absolute levels)

C) do you really think that it is negative that we are finally seeing economic growth in India and China so that some Indians and Chinese no longer need to live in absolute (not relative) poverty

D) a tax reduction (de facto a lowering of the price of government "services") is not and never will be a hand-out; the rich are still net payers after such a reductio (and paid a higher shar of the revenues to the government than in just about any other period we have ever lived in)

David Friedman writes:

David H:

It isn't a question of absolute vs relative but of stocks vs flows.

Robert Frank's claim is about the number who never make it out of poverty. Suppose that, at some time in the past, there were lots of poor people but so much mobility that everyone born poor ended up not-poor--replaced by new people born poor. The percentage who never made it out of poverty would be zero. At some later time, with the same absolute definition of poverty, you could have many fewer poor people, but everyone born poor dies poor, so many more people are failing to make it out of poverty.

The change between the number of poor people at time 1 and the number at time 2 doesn't tell you how many people made it out of poverty because the poor people at time 2 need not be the same people who were poor at time 1.

David R. Henderson writes:

@David Friedman,
Aha, now I get it. I agree with your criticism.

ThomasH writes:

I do not understand why justified pride in how much better off the poor in the US are today (partly because of re-distributive policies) compared to average income 50 years ago or compared to the poor of other countries should in any way should diminish concern about a trend in pretax income and benefits and in wealth to become less equally distributed.

David R. Henderson writes:

@ThomasH,
I do not understand why justified pride in how much better off the poor in the US are today (partly because of re-distributive policies) compared to average income 50 years ago or compared to the poor of other countries should in any way should diminish concern about a trend in pretax income and benefits and in wealth to become less equally distributed.
Because what I care about, in the economic realm, is people being better off than they were.

And all of Frank's arguments ignore the changed incentives that today face the poor. Do higher minimum wages that make it difficult, if not impossible, for a low skill worker to get his first foot on the economic ladder, minimize or maximize inequality?

Does the Dept. of Education, militant teachers' unions and high levels of spending on government schools help or hurt the children who live in low income neighborhoods, get an education with skills that will help them in the employment marketplace?

Do unionized public sector workers who can make or break a political party's electoral prospects, promote opportunity for today's low income earners?

I've hardly exhausted the questions.

Tom Maguire provides another example of government's contribution to increasing inequality;

In short, Obama is paying low and middle-income people more if they avoid marriage. Is this really sound social policy? I would guess not. But it is politics as usual for the party that thinks a woman's most meaningful long term relationship is with the state.

Mark Bahner writes:
True. But there's a solution: go to a community college for two years, earn your associate's degree, and then go to a state college for 2 years.

Most of what I know about this comes from reading (and then promptly forgetting) articles in MIT's Technology Review.

I think MOOCs are going to transform higher education, such that a relatively poor person anywhere in the world will be able to claim (and demonstrate) having mastered the finest courses from the finest professors.

The MOOCs are coming; actually, they're already here

Troy Camplin writes:

In a scale free network such as a completely free market economy, you are naturally going to get a power law distribution of wealth (number of links/interactions). In such a network, it is the number of links which matter in creating wealth.

In a hierarchical network such as you find in a firm, or in government organizations, you have a different architecture. Those on the top are wealthier than those under them (that wealth may be in power, reputation, etc.) through the strength of their links/interactions (the better your relations with your boss, the more likely you are to move up -- a few strong bonds are here better than many weak bonds).

When people complain about wealth distributions, they think all bonds are of the latter kind. They do not consider the fact that in a free economy, organizational hierarchies matter far less than scale-free network links. Bill Gates is a billionaire because he engaged in more economic transactions than have most people. However, the management of Microsoft is as it is because of the strengths of the bonds each person in the firm has with Bill Gates himself.

In a free market, quantity of links matter; in an organization, quality of links matter. There is a big difference between these two statements.

In the first case, one cannot make a rational argument against how wealth is created and subsequently distributed throughout the economy. In the latter case, however, one can reasonably make observations about desert, etc.

In short, Frank is making the age-old socialist error of thinking the economy is an organization. It is not. It is a self-organizing scale-free network process. The structural architectures are utterly different.

I will note, however, that the more government regulations there are, the more rigid -- and therefore more hierarchical -- the network becomes. Thus, the fact that he is seeing the rich get richer may be an indication that the government is overregulating the economy.

However, we would also expect in a scale free network to see the rich getting richer at a faster rate than the poor getting richer (though we ought to see that, too).

So how can we tell the difference?

In a scale-free network, we would expect to see the poor get richer even as the rich get richer still. Further, we should see a power law distribution of wealth. If the power law distribution breaks down, we will see the economy weaken and become more rigid and organizational in structure. Coincidentally, redistributing links in a scale free network will cause the network to become rigid, then collapse, over time.

In an organizational network, we would expect to see the rich get richer and the poor remain the same. The distribution is not necessarily a power law, as strength of bonds matter more than numbers. Political connections are all of this kind.

So, which are we seeing? The kind that shows we have a healthy economy, or the kind that shows a rigidifying economy? I suspect the problems Frank is seeing are caused by government rigidification.

Floccina writes:
But perhaps the most important new feedback loop shows up in higher education. Tighter budgets in middle-class families make it harder for them to afford the special tutors and other environmental advantages that help more affluent students win admission to elite universities. Financial aid helps alleviate these problems, but the children of affluent families graduate debt-free and move quickly into top-paying jobs, while the children of other families face lesser job prospects and heavy loads of student debt. All too often, the less affluent experience the miracle of compound interest in reverse.

I would expect that those set to inherit large fortunes to less motivated than those who expect to inherit little.

LD Bottorff writes:

Robert Frank expresses concerns with reductions in taxes and regulations as contributing to greater wealth and income inequality. He does not mention other forms of rent-seeking. I consider the housing policies of the last 20 years to be an example of inappropriate rent-seeking and it has certainly skewed the wealth concentration (in terms of housing values) towards certain areas of the country. However, fretting over income and wealth inequality is likely to result in more rent-seeking, not less.
Basically, no matter how good their case is (and I don't concede that it is good at all) I don't trust people like Robert Frank or Barack Obama to figure out a way to 'fix' it that doesn't screw things up worse.

Brian writes:

"In a scale-free network, we would expect to see the poor get richer even as the rich get richer still."

Troy,

Can you explain why you think this? It seems to me that the ratio of rich-poor wealth should be determined by the exponent of the power law and wouldn't change unless the power law changed. Is there a reason to think that the powere law is changing in a scale-free network?

Troy Camplin writes:

Brian,

That's actually a very complex question. :-)

One expression of the power law distribution in a scale free network is the 20-80 division. 20% of the population have 80% of the wealth. As a consequence, if your economy goes from $1 trillion to $2 trillion, the top 20% will go from having $800 billion to $1.6 billion, while the bottom 20% will go from having $200 billion to $400 billion. If, for purposes of simplification, we assume a steady-state population, we will see that the bottom 80% are twice as wealthy as a group -- but so are the top 20%. Note that we also see the rich getting richer and the distance between the top 20% and the bottom 80% getting greater; however, we also see the bottom 80% getting wealthier as well.

When discussing the economy -- the system of mutual exchange -- as a scale free network, we need to understand that you get a link every time you engage in a transaction. The more mutual exchange transactions you engage in, the wealthier you will become. Each party is better off after the transaction. When you earn money, it's a gain, and when you spend money, it's a gain. However, some people engage in more economic transactions than others. I engage in relatively few economic transactions; Bill Gates engaged in a quite large number of economic transactions over his lifetime. Neither of us have lost any links, but have only gained them over time. In this sense, once you enter into the system of mutual exchange, you can only benefit with each transaction, adding more and more links.

This of course does not account for ways in which the equivalent of a "broken link" could occur. Taxes at the very least prevent mutual transactions from taking place (assuming zero effect), and likely result in the equivalent of breaking links, thus impoverishing people relative to their current or potential wealth. A law protecting one business from competition has the same effect -- it effectively breaks links, or at least prevents links from being made.

Also, there is more than one kind of scale-free network architecture. There are physical limitations that make such networks increasingly polycentric over time, as more and more links are made. Thus, one would predict that in a freed market, the network architecture would decentralize and make even more people even wealthier, with the gap decreasing. We see this, for example, in the global network of airports. There used to be a very small number of extremely large airports, but the more air traffic, the more large hubs were needed, and now we have several airports in the U.S. that are huge, with ah huge number of medium-large airports. Thus, increased size resulted in a natural redistribution of wealth.

Andrew_FL writes:

That article is, I think, quite revealing about the thinking of some fighting "inequality." He is literally applauding the notion of families never making progress through the generations, but instead them backsliding into poverty.

So then it would appear to me that his goal is not to make everyone well off, but to make everyone perpetually impoverished.

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