Jazz musicians hear music differently than casual listeners. We hear the underlying chord structures that support the melody. For example, when we hear the TV show theme from “The Flintstones,” we immediately think, “That’s George Gershwin’s ‘I Got Rhythm.’” When we hear George Russell’s, “Ezz-Thetics,” we think, “That’s Cole Porter’s, ‘Love for Sale.’” The melodies may be completely different, but the harmonics are identical.
In a similar way, economists see the world differently from other observers. We see the stocks and flows, the accumulations and feedbacks, the cause and effect. For example, when we see one short line and one long line at the grocery store, we think of terms such as “arbitrage,” “transaction costs,” and “asymmetric information.”
As a less trivial example, when we see a fellow buying a pack of cigarettes at Hannaford, we see a guy who is willing to pay the taxes that we rightfully should be paying instead. We see a guy who will likely cost the Medicare system huge amounts of money later in life. We also see a guy who will likely not collect much of his social security benefits.
Another piece of the economic landscape observed from a different vantage point concerns the idea of income distribution and redistribution. We observed last week that throughout the world a relationship exists between economic upward mobility and income equality. Specifically, countries that have created economies of genuine equal opportunity also have much more equality in outcome. The one gets you the other.
Several surveys over the years have time and time again confirmed the consensus that the vast majority of economists believe that income redistribution is an appropriate and important role of government. In contrast, far fewer noneconomists share the same opinion.
I suspect that the difference between economists and noneconomists on this issue is one of communication. Generally, the public (especially those who sit in the chairs to the political right) has visions of income redistribution as taking money from hard-working families and giving it away to people who lounge in front of publicly purchased 65-inch LCD screens leering at “I Love Lucy” and guzzling liters of lager.
With our idiosyncratic eyes, economists see income distribution in an entirely different light. The distribution of income arises from policies. When we open trade with China, we redistribute the gains from trade in a way that makes consumers better off. But some families who have relied on manufacturing for employment are made worse off. In other words, we have redistributed income.
When we determine that it is economically efficient to have the government build roads and bridges, we fund those through income taxes that redistribute income. When we grant a patent for a product, it redistributes income. When we determine that gasoline consumption is contributing to global warming, and hence place a large tax on petrol, we redistribute income.
(That last example might not be obvious. For most people in the U.S., middle-income households buy about as much gasoline as high-income households. As such, the gasoline tax is highly regressive since both households pay the same amount regardless of income or ability to pay.)
North Americans believe in opportunity. Nearly everyone shares the sentiment that hard work and perseverance mixed with a degree of talent should rightfully result in a reasonable reward: some degree of economic prosperity. This is the American Dream. Regardless of one’s race, creed, or color, opportunity should be open to anyone who is willing to pay the dues.
Economists typically place the factors that determine opportunity into three categories. These include the family structure, the labor market structure, and public policies. Unfortunately, in the U.S., all three categories militate in such a way as to mitigate opportunity. For the past 40 years or so, we have steadily nudged our economy in ways that reinforce economic rigidity rather than mobility. We have gradually yet persistently closed the doors of opportunity.
How do we know this? Many decades of detailed census data are available throughout much of the world. Parents and children can be tracked with a reasonable degree of economic accuracy. From the data, economists have constructed a statistic known as the Intergenerational Elasticity of Earnings. Apparently, all the good names for a statistic were already taken, so they went with that one.
The elasticity works as follows: Children are placed into, for example, five income cohorts from poorest to wealthiest. The children are tracked throughout their careers and placed into similar categories or earnings cohorts. From this, econometricians (economic statisticians) can determine the probability of a person born into one cohort remaining in that same cohort versus moving into another.
If a country has perfect mobility — absolute equal opportunity — then we would expect that the probability of a person remaining in the same cohort or moving to one of the other four to be equal at 20 percent — or one out of five. If a country has no mobility, the probability of remaining in the income cohort into which one was born would be 100 percent — or one.
From this data, economists turn the probabilities into an elasticity that runs from zero to one, one being associated with no mobility and no opportunity, and zero being perfect mobility and perfectly equal opportunity.
We noted last week that the U.S., Italy, and the U.K. have the least mobility, the highest score on the Intergenerational Elasticity of Earnings among the developed nations on the planet. We also have the highest income inequality. The two go hand in hand.
Public policy, labor market institutions, and family structures have all combined to move us away from opportunity. In other words, we have been redistributing income from the lower, middle, and upper-middle classes to the very wealthy by restricting opportunity. Specific policies in the U.S. have created our modern distribution, our modern opportunity set. We will examine these in more detail next week.
(Marcus Hutchins is a former economist, treasury-bond arbitrage trader, and hedge fund manager. He retired to Southport in 1997, where he resides with his wife, Andrea, and youngest daughter, Abbey. He welcomes feedback at email@example.com.)