Institutions Matter Except When They Are Socialist

Robert Solow once remarked:

Every discussion among economists of the relatively slow growth of the British economy compared with the Continental economies ends up in a blaze of amateur sociology.

This is the final move of right-wing economists whenever the assumptions of their ideologically-infused policy prescriptions end up contradicted by observed reality. After a few forays into some exotic economic indicators, they eventually propose strange half-assed sociological theories that, quite remarkably, end up concluding that laissez-faire capitalism is still definitely the way to go. As with most things, the conclusions never change, but the rationales radically shift from moment to moment.

Given the more than respectable performance of Nordic economies over the last century and half-century especially, they are now natural targets for the amateur sociology of cynical peddlers of laissez-faire.

The descendants of Scandinavian migrants in the US combine the high living standards of the US with the high levels of equality of Scandinavian countries. Median incomes of Scandinavian descendants are 20 per cent higher than average US incomes. It is true that poverty rates in Scandinavian countries are lower than in the US. However, the poverty rate among descendants of Nordic immigrants in the US today is half the average poverty rate of Americans – this has been a consistent finding for decades. In fact, Scandinavian Americans have lower poverty rates than Scandinavian citizens who have not emigrated. This suggests that pre-existing cultural norms are responsible for the low levels of poverty among Scandinavians rather than Nordic welfare states.

What’s funny about this analysis is that it is, in a sense, right. It just seems to totally misunderstand how the causal arrow functions here. The Nordics have long had a very egalitarian cultural tradition. And this is arguably why they opted for social democratic institutions to handle the set of technological shifts related to industrialization. And this opting for social democratic institutions is why they’ve managed to keep things more equal and less impoverished than other countries that responded to industrialization in a more sadistic manner in keeping with their garbage cultures (like the US and the UK).

But crucially, it is the institutions that are doing the proximate work of achieving egalitarianism. The cultural point can help to explain why they went for those institutions when others didn’t, but it doesn’t negate the fact that those institutions are what’s doing the work. This is an identical point as the one about so-called “homogeneity.” Certainly the fact that the white majority in the US hates black people a lot makes it hard for us politically to get good egalitarian institutions, but that doesn’t mean that if we got them, they wouldn’t work. It just means we wont get them because of racism.

Both the racism and cultural egalitarianism point are very good reasons to be skeptical that the US has what it takes to get egalitarian institutions going. But it does nothing to say that those institutions don’t work. It’s a political point not a policy point.

We know, of course, that Nordic-like institutions that non-Nordic countries have do, in fact, work very similarly. The US has a solid old-age pension scheme in Social Security and it has wiped out the vast majority of old-age poverty in the country. The UK, under Blair, dramatically ramped up transfer payments to parents with children and cut child poverty in half in a decade. Because these countries are broadly shit countries, they may very likely unravel these programs. In fact, the Tories are gearing up to unravel the child poverty gains as we speak. There is no doubt a cultural explanation for why a country like the UK is willing to blow up child transfer payments while most Nordic countries aren’t, but it’s the child transfer institutions that’s doing the proximate work of securing low or high child poverty in the various countries.

The Social Democratic Sharing Economy

In a new piece in Democracy Journal, Nick Hanauer and David Rolf argue that, in response to the rise of the sharing economy, we need to transition away from our employer-provided welfare benefit system to a more public system. Jeff Spross had a nearly identical (though considerably shorter) argument in The Week earlier this month. While I obviously am a huge fan of taking welfare benefit delivery out of the employment relationship, the approach outlined by Hanauer and Rolf has a lot of flaws.

As an initial matter, it’s worth noting that Hanauer and Rolf basically just reinvented a social democratic welfare state without seeming to realize that’s what they were doing. This is not a knock against them per se. In fact, it’s very heartening to see people independently reach the same conclusion about how best to run an economic system. However, reinventing social democratic institutions in a vacuum without looking at and borrowing from other social democratic states is bound to lead to oversights. Hanauer and Rolf’s social democratic proposals are first drafts while the social democratic systems that already exist are on their 50th or later version by now.

Flat Taxes and Shared Security Accounts

The first big flaw in Hanauer and Rolf’s plan is that, despite nominally trying to delink welfare benefits from employment, they end up constructing a system that is almost obsessively keyed to earnings.

At the heart of the proposal is a Shared Security Account given to each worker, which is effectively financed by flat taxes on earnings (they call it “prorating” but it’s the same thing). They describe it this way:

The obvious solution to the explosion of part-time work—voluntary or otherwise—is to prorate the accrual of benefits on an hourly or equivalent basis. For example, if Zoe works 30 hours a week at the hotel, she should earn three-quarters of the benefits offered by a full-time 40-hour-a-week job; if she works 20 hours a week, she should earn half the benefits. There is no doubt that many employers push their employees into part-time work in order to avoid the added cost of paying any benefits at all. Proration would eliminate this perverse incentive and the economic distortions and inefficiencies that come with it.

To be clear, proration is not a radical idea. Social Security and Medicare have always been prorated: Zoe’s employer pays half of her 15.3 percent combined Social Security and Medicare tax, regardless of how many hours she works. But all mandatory benefits that normally accrue to full-time employees on a daily basis—sick days, vacation days, health insurance, unemployment insurance, workers’ compensation insurance, retirement matching, Social Security, and Medicare—should also accrue to part-time employees (hourly, salaried, or contract) and sharing-economy providers on a prorated hourly or equivalent basis.

There is a lot wrong and just unnecessary about this. For starters, health insurance is not able to be “prorated” like all of the other stuff: you can’t give someone 50% of health insurance because they have 50% of the earnings of someone else. Health insurance is not really divisible in that way. This is why normal countries guarantee health insurance as a right unrelated to earnings or anything else.

Even for benefits where prorating is practicable, it’s not a good idea. What prorating envisions is a system where, for example, every person pays 3% of their earnings to unemployment insurance taxes and then receives 60% of their earnings in unemployment benefits should they find themselves unemployed.

This might seem like a very clean implementation (same percentages for all people!), but the cleanness is an unnecessary and ultimately unhelpful gimmick. Instead of dedicated prorated taxes, it makes more sense to use general taxes that levy more from higher market incomes where possible. Instead of prorated earnings-related benefits, it makes more sense to have earnings-related benefits with wage replacement rates that taper off for higher earnings (e.g. unemployment benefits that pay out 75% of earnings for first $40,000, 50% of earnings for next $40,000, and 25% of earnings for remaining income). This makes basic functional sense because people with lower earnings need higher replacement rates to be able to avoid hardship and it helps to cut inequality in the process. I use unemployment insurance as the example here, but the analysis equally applies to retirement, worker’s compensation, disability benefits, and other medium to long term job leave.

Missing Benefits

Because Hanauer and Rolf are so honed in on earned prorated welfare benefits, they predictably miss important benefits that don’t really operate that way. Certain benefits like retirement and disability and sick days can easily be fit into the prorated Shared Security Account framework (even if unwise). Other benefits like child care, education subsidies, and child allowances simply cannot. Which is to say: family benefits necessarily get short shrift in this kind of scheme.

For parents of children, flat and equal child benefits (not earnings-related prorated benefits) are the far superior option. It wouldn’t make sense to provide prorated child care benefits because child care costs the same regardless of how much money you make. Similarly, it wouldn’t make sense to pay out a prorated child allowance: clothing, feeding, and housing children costs the same regardless of how much money the parent makes. Education operates the same way.

You could theoretically hive off the benefits that don’t really fit into the prorated Shared Security Account scheme and run them through some separate scheme, but this is inefficient and duplicative. An ideal social democratic system will have one social insurance institution that is able to coordinate all transfer payments. Having some payments run through this Shared Security Account gimmick and others through some other systems creates needless complexity that would also likely recreate certain stigma problems we already have wherein things like Social Security transfer payments are treated as legitimate and good while other transfer payments are seen as shameful and bad.

Decommodify Totally

Finally, the Hanauer and Rolf social democratic proposal is flawed in that it gets off on the wrong philosophical foot, which also contributes to its technical limitations. For Hanauer and Rolf, these welfare benefits are supposed to be essentially job benefits, even though they are administered publicly. This differs from the traditional reason for these benefits, which is to provide for people’s basic material security in a decommodified way that is significantly detached from earnings and jobs.

The decommodified approach says that everyone deserves health care, education, and an adequate minimum income regardless of the market and regardless of their location in the economic system. Building out these welfare benefit structures through dedicated prorated taxes on earnings that fill up dedicated individual social security accounts that pay out dedicated prorated benefits does nothing to delink the benefits from market actions and thus recreates a lot of the same problems employer welfare benefits have (including the inability of employer welfare systems to really provide for lower earners).

Under a decommodification approach, you would never get stuck in all of the needless prorating and account-making mistakes discussed above. Instead, you’d identify basic needs, figure out what welfare institutions would satisfy them, and then establish a tax level high enough to fund them.

The sick and injured need health care, so you provide universal health insurance. Children need care, education, and income (they don’t work), so you provide child care, education, and transfer payments to their parents. Unemployed people need income. So you provide them income, most likely in a way that is related to their prior earnings for smoothing purposes (but not based on some fictional account they have contributed to). Retired people and disabled people also need income and so you also provide that and also do so most likely in an earnings-related way (with wage replacement rates that taper as earnings go up) for smoothing purposes. And so on.

If we are going to transition into a new welfare benefit scheme in light of the rising sharing economy, that scheme should not try to recreate the existing work-pegged system in public form. It should break from that model entirely, focusing instead on creating a universal public scheme aimed specifically at meeting everyone’s needs, not administering “earned” benefits.

Does brand differentiation lower prices?

Over at the Demos dot org slash blog, I discussed this Bernie Sanders quote:

If 99 percent of all the new income goes to the top 1 percent, you could triple it, it wouldn’t matter much to the average middle class person. The whole size of the economy and the GDP doesn’t matter if people continue to work longer hours for low wages and you have 45 million people living in poverty. You can’t just continue growth for the sake of growth in a world in which we are struggling with climate change and all kinds of environmental problems. All right? You don’t necessarily need a choice of 23 underarm spray deodorants or of 18 different pairs of sneakers when children are hungry in this country.

The media seemed to have missed the point of the bolded part in which Sanders makes fun of those who say egalitarian policies will cut down on innovation. This was the subject of my Demos post.

In the aftermath of this comment, there was another less important thread that I also want to comment on. Multiple people (again in media) tweeted at me that this market of 23 brands of deodorants competing with each other brings prices down and therefore makes people less poor (adjusted for the cost of deodorant). Like most Econ 101 truisms, this is not exactly right.

If things are working according to design, the way you would get the cheapest possible deodorant prices is by commoditizing deodorant and then having firms compete to provide it in its commoditized form. By commoditize deodorant, I mean make deodorant akin to soybeans and corn, where one train car of deodorant is totally indistinguishable from any other train car of deodorant. In a world with commoditized deodorant, firms competing in the deodorant space will only be able to compete on price because there is no other way to distinguish deodorant units from one another.

The major point of brand differentiation is to fight commoditization. The goal is to make it so that you do distinguish between Speed Stick on the one hand and Old Spice on the other, instead of just categorizing them at Deodorant.jpg. If you can successfully pull off the marketing and branding, you don’t have to compete absolutely on price anymore, and so you can charge more (and make more profit) than if you were dealing with a pure commodity. The teen boy who has seen your slick ads must have Axe, regardless of whether it’s actually physically distinguishable from other deodorants, and so you can score extra margin out of that marketing-induced consumer preference.

So, in fact, extreme brand differentiation of the sort Bernie jokes about is not about driving prices down, but rather driving prices up by getting people to spend more on deodorant for brand premiums. Now, of course, defenders of this would say there must be something of true value in the extra money you can charge for a brand. Don’t they feel better for buying the cool deodorant than otherwise? Is that psychological feeling not real hedonic value? And, maybe it is, maybe it isn’t. However the point is that this sort of thing is not about competition driving down prices, but rather competition pushing innovation to give people different deodorant experiences at different price levels.

Ultimately, I really just could not care less about this whole topic (except insofar as I think its at least somewhat funny to mock “innovation” as inherently good). But if you are going to lose your shit over it and prove how smart you are on the internet about it, pretending as if deodorant brand differentiation is premised upon some vicious price war is not the way to do it.

Wages of Abstinence and Risk

Two posts ago, I rehashed the point that owners of capital income do not produce it and therefore have no desert-based claim to it. One post ago, I responded to the rebuttal that they do in fact do work to receive capital income, namely the work of deploying and managing capital. In that post, I rehashed the point that capitalists don’t do this work, but rather money managers and executives (who are paid) do it. So, it would seem, we really do have 30% of the national product flowing out to people who have no recognizable desert-based claim to it.

Of course, as I pointed out in my first post, this is not a total bar to arguing against the current set of arrangements. There still remains the utilitarian argument for them: regardless of whether capitalists can be said to deserve this 30% of the national income, providing it to them in the manner that we do creates specific price signals and incentives that leave people much better off than if that 30% was distributed in some other manner. This is a viable enough argument (though I think it too is defective), but crucially it is not a desert argument. It does not proceed by explaining why specific capitalists can be said to individually deserve the income they receive based on their production; rather, it makes a much more collectivist welfare point about why it is good to give it to them anyways. (Although I won’t pursue it here, this is identical to the dominant argument for transfer incomes as well.)

You might think that the utilitarian argument would be enough to satisfy the pro-capitalist side. But, quite remarkably, it doesn’t seem to do so. Deep down, it appears that they still crave some way to attribute capital income to something the capitalist is doing. This impulse is understandable: it’s hard to legitimate a system that gives the wealthiest among us 30% of the national income each year while also admitting that they didn’t do anything to produce it. In the cloistered world of higher-level philosophical debates, you can sustain an argument of that sort. Selling it to struggling people who, though actually working for their income, receive a tiny fraction of what billionaires passively capture each year seems like it could be difficult. Those who receive this capital income don’t generally seem too enthused about the purely utilitarian explanation for it either.

When first faced with this problem, the natural first move appears to be to claim the capitalist is actually working. That was what my second post (linked above) was in response to. Once that is knocked down, the capitalist apologist moves into ever more abstract terrain.

Wages of Abstinence
Perhaps the most amusing of these more abstract individualist justifications for capital income comes to us from old-timey economist Nassau Senior. Senior argued that the capitalist is being compensated (and indeed deserves to be compensated) for their sacrifice in the form of abstaining from consumption in the short-term. You see, these people could have just gobbled up their income in leisurely ways, but instead they forwent that leisure and consumption and invested it, taking a short-term hit to their well-being that deserves recompense down the line. Although this “wages of abstinence” argument is initially an old-timey justification for capital income, I still see it pop up in debates all the time.

In my view, this argument was well-handled by Ferdinand Lassalle in his 1864 tract “Kapital und Arbeit”:

The profit of capital is the ‘wage of abstinence.’ Happy, even priceless expression! The ascetic millionaires of Europe! Like Indian penitents or pillar saints they stand: on one leg, each on his column, with straining arm and pendulous body and pallid looks, holding a plate towards the people to collect the wages of their Abstinence. In their midst, towering up above all his fellows, as head penitent and ascetic, the Baron Rothschild! This is the condition of society! how could I ever so much misunderstand it!

Lassalle’s quote contains a number of interesting, and I think correct, threads. One of those threads pertains to the compensation of what we might think of as inframarginal sacrificers. For those with huge stocks of money, like Baron Rothschild, it is hardly any sacrifice at all to defer the consumption of even the great majority of their fortune. What else are they realistically going to do with it? They already live lavish lives and consume all that they can realistically want. The level of short-term hedonic sacrifice involved in their investing their fortune rather than consuming it is zero or nearly zero.

At the same time, though not mentioned by Lassalle, poor people who take pains to save money undertake relatively huge short-term sacrifices while receiving nowhere near the same compensation for that sacrifice as the super-wealthy. Even compensation per unit of capital invested clearly does not match sacrifice levels as the rich and poor receive the same compensation despite dramatically different levels of sacrifice involved in making the investment. (In reality, the rich actually receive higher return on capital than the poor, making this problem even worse.)

Risk
After wages of abstinence fades away for the silliness that it is, we are then told to look towards risk. You see, the capitalist doesn’t just put capital in and get passive income out. There is at least some chance that they don’t get passive income out and may even take losses. Indeed, the compensation of capital investment directly relates to the risk that such a thing will happen.

As I pointed out earlier, this argument also is not compelling. Under capitalism, two people taking on identical risks (e.g. equities with the same risk profiles) do not receive identical compensation for doing so. In fact, that is integral to the whole idea of risk. Compensation on the basis of risk is no different, on an individual deservingness level, than compensation for lottery winnings. In both cases, money is put into the system with some level of risk of loss (in the lottery winner’s case, huge levels of risk) and then, if you are a lucky one, you get a bunch of money out. This compensation is not based on individual desert (whether productive or otherwise); rather, it is based on the exact opposite of it: randomness and good fortune. It’s gambling.

“Have I Myself Not Worked?”

In my prior post, I pointed out that capital income is paid to non-productive people who don’t, under a labor-desert theory of entitlement, deserve it. In response to this explanation, some commenters have said that in fact capitalists do work in some way. It’s not that they just have capital and then income flows to it: they actually have to do work in planning how to employ it or hire workers to run the machines and so on.

I always thought Marx’s response to this particular argument was rather amusing:

Our [capitalist] friend, up to this time so purse-proud, suddenly assumes the modest demeanour of his own workman, and exclaims: “Have I myself not worked? Have I not performed the labour of superintendence and of overlooking the spinner? And does not this labour, too, create value?” His overlooker and his manager try to hide their smiles. Meanwhile, after a hearty laugh, he reassumes his usual mien.

Of course the planning and deployment of capital involves labor. But, as Marx points out, the capitalist does not do this labor. He hires other people — executives, bankers, and money managers — to do this labor. And, indeed, in the national accounts the money paid out to these kinds of people is scored as labor income. Capital income is thus the amount of money that flows to capital after the managers of the capital have been paid their labor income for managing it.

To be sure, sometimes capitalists are owner-operators of their capital and this ends up mushing together capital and labor income in such a way that makes it hard to disentangle. Someone who owns their own business and all the capital in it receives labor income from their work as a manager of the capital and capital income from the capital itself. Normally, income of this sort (self-employment income) gets portioned out as partially from capital and partially from labor when people are trying to estimate economy-wide aggregates.

What’s remarkable to me about the “have I myself not worked” defense is that, these days, it’s easier than ever to identify people clearly receiving pure return on capital. People who own capital are not generally also managing that capital in any meaningful way. Instead, they are invested in funds that buy up equity (and bonds) in thousands of different companies. They pay a management fee to whoever is running the fund (which is labor income) and the companies they are invested in compensate their executives (which is also labor income). So compensation for the work of managing capital ends up pretty neatly hived off from the pure return on it.

Anyone who is invested in a 401k or IRA should fully appreciate this as well. What production are you involved in when you click the button on the website that puts the money from your checking account into the index fund? Hell, sometimes you don’t even have to do that because your employer just puts the money straight into the index fund on your behalf!