Stupid rich people — Ezra Klein on inequality

The super-rich aren’t super-smart says Ezra Klein. While it might be comforting to believe that that income differences represent differences in knowledge and skill, it’s just not true:

The massive gains in wealth in this country are apportioning to a small slice of rich people at the very top of the income distribution, not the broad mass of skilled, college-educated workers who hoped they were buying into the economic ruling class but, in fact, are just the new middle. We’ve built an economy where the riches go not to those with the most knowledge, but the most money.

Matt Yglesias isn’t convinced. He points to a 2007 report by Jared Bernstein and Larry Mishel which shows that college graduates still earn significantly more than those with only high school. There "was a huge run-up in the wage premium in the 1980s" writes Yglesias, and "that hasn’t declined at all." So in other words, differences in human capital still explain a great deal of the inequality in incomes.

Of course Yglesias admits that "it’s a mistake to monomaniacally focus on educational attainment as the only factor driving inequality" and the Bernstein and Mishel paper he links to makes that point clear. But he insists that the college wage premium endures partly because of "inadequate preparation for students from disadvantaged backgrounds and screwy priorities on the part of institutions of higher education".

In a follow up post Klein points out that income inequality kept increasing even when growth in the college wage premium stalled:

If inequality is a simple function of educational attainment, then the economy remains a relative meritocracy, and reversing the trend is a simple matter of sending more people to school (though, as Matt does point out, that’s easier said than done). If not, then it’s a function of any number of forces, ranging from globalization to tax rates to corporate culture, that speak to deeper inequities in our economy, and might require more direct government intervention.

Klein and Yglesias are largely arguing past each other. Klein focuses on spectacular increases in income at the very top of the distribution while Yglesias pays more attention to differences nearer the bottom. Klein doesn’t explain how reining in incomes at the top would help those with incomes at the bottom, and Yglesias doesn’t claim that the rich could become super-rich if only they got a better education (for an amusing take on the plight of the merely rich, watch this video).

What’s really going on here?

Klein’s interest in the causes of inequality waxes and wanes. What he’s really interested in is getting the government to do something about it. Last year he wrote:

Whether inequality is a result of skills-biased technological change or low marginal tax rates or Wall Street or the inequality gnomes is really neither here nor there.

So why is he arguing with Yglesias about the causes of inequality? The reason is that Klein is trying to sell redistributive policies to readers who believe their country ought to be a meritocracy. A large proportion of Americans (particularly white educated Americans) believe that differences in income are fair if they are the result of talent and effort. And rather than argue with his readers about values, Klein sets out to convince them that increases in inequality are not the result of differences in ‘merit‘.

In an earlier post Yglesias writes that "Oftentimes … liberals act as if the thing that needs to be done is to prove somehow that inequality has exploded because people are in some sense ‘cheating’". And that’s exactly how Klein is acting in this latest exchange with Yglesias.

Klein gets drawn into this debate because his conservative opponents are constantly cooking up enormous stews of data in an effort to convince readers that the free market rewards the talented and virtuous. Some of these arguments are so outrageous that it’s difficult to resist arguing back. Even free market champions like Friedrich Hayek acknowledged that these claims don’t hold water (the ‘Ecclesiastes effect‘ remains strong).

Klein has now become so anxious to discourage the idea that differences in income have anything to do with differences in merit that he’ll attack anyone who suggests that there is a correlation between investments in human capital and market income. To do so is — in Klein’s mind — the same thing as conceding that income inequality is morally justified.

No philosophy please, we’re Liberals

Klein’s thinking starts and ends with policy. Being a Liberal means building coalitions, winning power and getting down to work on a long to-do list — taxing the rich, supporting Medicare, defending Social Security and so on. It’s projects first and principles second — or better still, projects full-stop. There’s just no room for abstract philosophising. (Watch this video to see how frustrated that makes Cato’s Will Wilkinson.)

Ironically, Klein’s no-philosophy strategy is similar to philosopher Richard Rorty’s. In an article for the Nation Rorty argued against appealing to principles:

Plausible principles are usually too uncontroversial to help one decide which projects to support. I suspect that anybody who thinks of him or herself as leftist would be happy with the most famous principle put forward by a political philosopher in recent decades, John Rawls’s Difference Principle: "Social and economic inequalities are to be arranged so that they are both (a) reasonably expected to be to everyone’s advantage, and (b) attached to positions and offices open to all." The trouble is that most people on the right are happy with it too.

You do not encounter many Republicans who tell you that we shall always have the poor with us, that deep inequalities are necessary for the successful functioning of the economy. Rather, Republicans argue (and most of them actually believe) that since the best poverty program is a thriving economy, and since such an economy requires that people who have money send it to their stockbrokers rather than to the government, redistributionist measures will not be to the advantage of the least advantaged. Such measures, they say, even though adopted with the best of intentions, turn out to violate Rawls’s principle.

When we on the left argue with Republicans who take this line, it is not about principles. Rather, we insist that a thriving economy can afford redistributionist measures, and that a rising tide will raise all boats only if the government constantly interferes to make sure it does. All the fruitful arguments are about facts and figures, about the concrete consequences of the passage of specific pieces of legislation.

Politically this can be useful position to take. Klein seems to regard political philosophy as a game for losers — people like libertarians:

Libertarians, who’re something of an ideological movement without much hope for political power, tend to spend a lot of time puzzling through the theory and philosophy of their ideas. Liberals, who’re something of a political movement without much hope for ideological purity, tend to think through policies and outcomes.

This is another way of saying that Liberals generally agree about the policies they support but disagree about why. This is why talking about policy unites the movement, while talking about principles fragments it. Naturally everyone has their own moral principles, but playing the game means keeping them to yourself. Only the most vacuous and general statements of principle are safe to say out loud.

The constraints of practical politics mean that Klein will never explain why he thinks that inequality is a bad thing. As a result, his arguments about solving the inequality problem will always end up looking like half the premises are missing.

Klein will happily say that rising income inequality is a bad thing. He’ll argue about how to measure it, and — when he’s in the mood — argue about what’s causing it. But what he won’t do is say why anyone ought to care if inequality rises or why government ought to be responsible for fixing the problem. If you were to ask whether inequality would necessarily be such a bad thing if the same things that drove up inequality also made the poor better off, Klein would probably dispute the idea that rising inequality really was likely to make the poor better off.

But maybe Klein is right. In the real world, political battles aren’t won by those with the best analysis and the most complete arguments. Just as high incomes go to those with the most money, the ability to shape policy goes to those with the most power … or something like that.

49 thoughts on “Stupid rich people — Ezra Klein on inequality

  1. Even free market champions like Friedrich Hayek acknowledged that these claims dont hold water (the Ecclesiastes effect remains strong).

    I think you’re overstating Hayek’s argument here. In the paragragh containing the reference to Ecclesiastes (pg. 126 – 127 of LLL II) Hayek uses terms such as “cannot be sure” and “not able to decide”. Hayek does not say the Ecclesiates effect dominates to the exclusion of everything else, simply that there is no mechanical relationship between effort and performance and reward. You’re doing well to say the effect is strong but after that your argument suggests that there is no relationship at all (or a random relationship) between effort and reward.

  2. I guess I would ask the question.

    If someone has a passion for something and the ability, then would it not seem logical that they do that something – even if not well paid?

    By that, I mean that the stats for income vs educational achievement may well be obscured by the fact that some people choose to do things that are not well paid – even though with their education they could do something more lucrative.

    As an example, would not someone whose passion was ‘making money’ and was good at their passion, be financially better off than someone whose passion was ‘saving eyesight’?

    Some peoples’ passion is not making money – but some of them make more in a weekend for a few hours (just to get some retirement funds) than they do for the rest of the working week when they work on what they like. Further, if they also have a passion for holidays, then that is also non-financial time – and may be a smarter thing to do than work slavishly to maximise income.

    ie, maybe the smart thing to do might not be to maximise wealth, but maximise a whole lot of other things.

    Finally – college education only looks at a particular type of ‘intelligent person’ maybe there is no reason for that sort of ‘smart’ to be better than the rest of the community for making money.

  3. Just as high incomes go to those with the most money, the ability to shape policy goes to those with the most power or something like that.

    I believe this is sheer nonsense in a functioning capitalist economy. It may be the case in Saudi Arabia etc. , but not the US or Australia.

    Warren Buffet, Bill Gates and Steve Jobs did not come rich families. Google wasn’t wasn’t heard of a decade ago. Apple was a start up in the 80′s and Microsoft was considered to be a small but never to be giant.

    Closer to home, Mac bank was the well managed offshoot of Hill Samuel- a UK investment bank.

  4. JC, no-one’s doubting that “rags-to-riches” is still possible in functioning capitalist economies, but surely the issue is whether it’s become statistically rarer. The vast majority of people that start with rags end up with, at best, slightly better quality rags, whereas the vast majority of people that with riches not only hold on to them, but increase them substantially.
    I don’t think there’s any getting away from the fact than those with money have significantly more opportunities to earn more money than those without (true, they also have significantly more opportunities to lose their money, but that seems to happen pretty rarely).

  5. Poor joice of examples JC.
    Courtesy of Wikepedia and easily verified.

    1) Warren Buffett was born in Omaha, Nebraska in August of 1930 to Howard and Leila (Stahl). As the son of a local stock broker, he was likely exposed to markets at a young age.

    2) Gates was born in Seattle, Washington, to William H. Gates, Sr. and Mary Maxwell Gates. His family was wealthy; his father was a prominent lawyer, his mother served on the board of directors for First Interstate BancSystem and the United Way, and her father, J. W. Maxwell, was a national bank president.

    3)Steve Jobs was adopted as an infant by Paul and Clara Jobs. Paul Jobs was a machinist for a company that manufactured lasers and Clara Jobs was an accountant

    All clearly reasonable well off people. Steve Jobs being most likely the most ‘humble’ beginnings.

  6. Sinclair – I’m happy to clarify Hayek’s views on merit and economic reward.
    In the Constitution of Liberty Hayek wrote:

    Most people will object not to the bare fact of inequality but to the fact that the differences in reward to do not correspond to any recognizable differences in the merits of those who receive them. The answer commonly given to this is that a free society on the whole achieves this kind of justice. This, however, is an indefensible contention if by justice is meant proportionality of reward to moral merit. Any attempt to found the case for freedom on this argument is very damaging to it, since it concedes that material rewards ought to be made to correspond to recognizable merit and then opposes the conclusion that most people will draw from this by an assertion which is untrue (93-94).

    As you suggest, this is not the same thing as saying that there is no connection at all between talent, effort and economic reward. There are two things worth noting:

    (1) Hayek claimed that neither inherited ability or the circumstances of a person’s upbringing had anything to do with moral merit. In CoL he wrote that "no more credit" belongs to a person "for having been born with desirable qualities than for having grown up under favourable circumstances."

    (2) In Law Legislation and Liberty (Vol 2) Hayek argued that "It certainly is important in the market order … that individuals believe that their well-being depends primarily on their own efforts and decisions." But at the same time he worried that this could go too far:

    … it leads no doubt also to an exaggerated confidence in the truth of this generalization which to those who regard themselves (and perhaps are) equally able but have failed must appear as a bitter irony and severe provocation (p 74).

    He continued by saying:

    It is probably a misfortune that, especially in the USA, popular writers like Samuel Smiles and Horatio Alger, and later the sociologist W.G. Sumner, have defended free enterprise on the ground that it regularly rewards the deserving, and it bodes ill for the future of the market order that this seems to have become the only defence of it which is understood by the general public. That it has largely become the basis of the self-esteem of the businessman often gives him an air of self-righteousness which does not make him more popular (p 74).

    On balance Hayek wasn’t sure whether it was better to encourage young people to think that if they tried hard they would succeed or emphasise the fact that some unworthy people would succeed and some worthy people would fail.

  7. MattG

    Those are hardly the product of the super rich.

    NPOV

    JC, no-ones doubting that rags-to-riches is still possible in functioning capitalist economies, but surely the issue is whether its become statistically rarer

    Is it? How so? You’re saying Forbes 400 and BRW 200 are static lists? I would say that if anything those lists are more volatile than ever.

  8. On balance Hayek wasnt sure whether it was better to encourage young people to think that if they tried hard they would succeed or emphasise the fact that some unworthy people would succeed and some worthy people would fail.

    Indeed. That is the issue. But there is a huge gulf between that nuanced view and what you wrote above.

    Even free market champions like Friedrich Hayek acknowledged that these claims dont hold water (the Ecclesiastes effect remains strong).

    These claims do hold water, but they cannot be the whole story and, as one of your quotes shows, they should not be the only claims in favour of the market system.

  9. JC
    They couldn’t have been described as struggling either.
    In fact their rags were probably better quality than the best threads of most people :)

  10. You’re right, matt, they didn’t come from the strugglers, rather were comfortable middle class. “Working families”, perhaps?

  11. The vast majority of people that start with rags end up with, at best, slightly better quality rags,

    Well, that’s true. only a few of us can ever be rich. However, the we shouldn’t lose sight of the most important issue here which is: are living standards rising.

    whereas the vast majority of people that with riches not only hold on to them, but increase them substantially.

    Well yea, that’s true unless you’re a spend thrift as all one has o do is spend a small proportion of the loot. That’s mainly due to the power of compound interest. I once read that over the time Kerry had the keys to the safe the family wealth grew at a compound rate of 5%. It’s not bad, but it’s hardly groundbreaking performance.

  12. JC, they needn’t be static lists, but the pool of people that are entering the list may well be shrinking.

    Even if it’s not, what would concern me more is the falling ability of those born into genuinely struggling families to even move just one step up the ladder into a comfortable middle-class existence. The vast majority of people have little realistic desire to be billionaires.

  13. N

    To be perfectly honest, just getting a trade will essentially put you in middle class existence as far as Oz in concerned. Even tradies think of themselves as middle class here.

  14. Well I’d certainly agree that “are living standards rising” is the most important issue for those at the bottom of the ladder.

    I just disagree that it’s safe to assume that as long as they’re rising at some non-zero rate, that there’s no need to be concerned about the rate at which the living standards of those at the top of the ladder are rising.

    If nothing else, it seems pretty self-evident to me that society would be better off if the living standards of those at the bottom were rising faster than they are now. And if one way to achieve that is to ensure that more of the wealth that is created by society goes to those at the bottom, then I don’t have an issue with it. I don’t even care particularly how it’s achieved – whether via increased income redistribution, or policies that better encourage the rich to spend their money in ways that benefit the poor the most, or through public funding of services that assist the less fortunate, or even regulation that caps employer:employee salary ratios (apparently this has worked in Norway, don’t know too much about it).

    Yes, there’s a risk that promoting such policies will dampen overall economic growth, but as I’ve said before, I’d much rather a medium-sized pie where everyone gets at least enough to eat, than a gargantuan one where 1% of the population have most of it, and the others are left to fight over scraps.
    As it is, I happen to suspect that such policies, if implemented sensibly, would actually help ensure economic growth could continue sustainably at a decent pace, whereas simply allowing all the wealth to accumulate at the top end would ultimately end in some form of economic and social collapse.

  15. JC, sure, and I think Australia still has quite good class mobility, and good job prospects for most. This is at least partly because Australia has done a better job at implementing wealth-distribution than the U.S., though of course it helps that Australia has been riding a wave of uninterrupted economic growth for the last decade or so, for which the previous government deserves at least some credit.

  16. “Id much rather a medium-sized pie where everyone gets at least enough to eat, than a gargantuan one where 1% of the population have most of it, and the others are left to fight over scraps.”

    There are several problems with this view. For starters, it’s a false dichotomy – that is not the choice our society faces. Secondly, it falsely assumes a zero-sum game. Thirdly, it’s illogical – if the pie is gargantuan enough, then a paltry share still means you get enough to eat. Fourthly, the most determined efforts to equalise the shares in the pie in history have typically meant great suffering and death (often by famine, in obscene irony). Lastly, the most unequal places in the world are the places where society hasn’t fully escaped feudal and semi-feudal arrangements that lock in the astonishing disparities that predominated centuries ago. Capitalism, contrary to old wives’ tales, is the enemy of feudalism.

    “simply allowing all the wealth to accumulate at the top end would ultimately end in some form of economic and social collapse.”

    I concur, sort of, even though you persist in erroneously thinking of wealth as some fixed amount that must be fought over. If the gap between the visibly wealthy and a sufficient number of comparatively-poor people gets big enough, there is a risk of strife. To my mind, this is one of the arguments in favour of some redistribution. But I don’t think much needs to be redistributed, and indeed nor should it – capital accumulation is the basis of progress and should not be prevented by making it pointless to do so by those most capable of doing so.

  17. Great call Fats.

    That’s the most impassioned comment I’ve seen for a long long time and I take my hat off to you.

    Extemnely impressive.

  18. Sinclair – If you say that the free market really does reward the talented and virtuous then the burden of proof lies with you.

    Be aware that I’ll deduct marks from your assignment if your argument lapses into circularity.

    For example, if you define ‘talent’ and ‘virtue’ in terms of the ability to produce goods and services that other people value, and then define ‘value’ in terms of market price you will not earn a passing grade.

  19. and then define value in terms of market price you will not earn a passing grade.

    It’s utility, Don. Not value. The market price/value in fact is in fact a ratio of what one finds useful (its utility) relative to other goods and services.

    If you say that the free market really does reward the talented and virtuous then the burden of proof lies with you.

    Einstein was talented. I guess you are too in your own profession. However talent is secondary to the goods or service you or anyone provide. I don’t much care if Steve Jobs, Bill Gates or the Google guys are talented, intelligent or good looking. All I am concerned is with two things. Are they providing me with a good or a service that I find useful (has utility) at a price I am prepared to pay?

    There is a difference between value and utility. It is actually an important distinction. Diamonds are valuable, but I wouldn’t pay or see the utility in a diamond if one was given to me (other than quick resale value). A diamond has very little utility for me even from an aesthetic point of view. However a good software program does.

    In my opinion I think your demanding Sinc to provide you with an explanation that is based on an incorrect premise.

    The market does not “reward talent or virtue”. The market basically rewards those who are able to provide goods and services that carry utility. Jobs is a talented guy and always will be a talented guy. However his talent is worth zero to me or anyone else if he is unable to supply me with goods for which I dont use (utility). He can die poor and talented for all we consumers care.

    Similarly I also find people confuse risk and reward thinking that people ought to be rewarded for taking risk. You can take lots of risk by betting on the winner of the next race tomorrow but I dont think they deserve to be rewarded for taking risk. Consumers never reward risk in of itself as that is basically of almost no importance. We reward those who can provide us with goods and service we value for their utility.

  20. “The market basically rewards those who are able to provide goods and services that carry utility”

    Sure – meaning it’s often not very good at rewarding people who do the necessary groundwork so that others can provide goods and services that carry utility.
    Like Einstein, who almost certainly did far more to raise living standards in the Western world than Bill Gates ever did. And further, while the market may be good at determining the value of the wealth created by a corporation that sells goods and services, I’m far less convinced it’s very good at determining how much of that wealth should go to the CEOs vs their employees. I don’t dispute for a moment that Microsoft has created many billions of dollars worth of value over the years – but is it really reasonable to suggest that, out of a company with nearly 80000 employers, Bill Gates has been personally responsible for even as much as 5% of it?* Why is it, for instance, that employer:employee salary ratios are so much greater today in the US especially than they a) were 30 years ago and b) are in most other Western nations? Are US employers really *that* much better?

    Regarding my previous post, I don’t believe I ever implied that I thought wealth was some fixed-size quantity, and my previous posts should have made it pretty clear I didn’t believe this – and as I’ve commented before, I don’t believe anyone seriously believes it is. My statement “allowing all the wealth to accumulate at the top end” was hyperbole – but it reads somewhat better than, e.g. “allowing 90% of a nation’s wealth to accumulate among the top 10%”.

    * Microsoft actually isn’t the best example here – Bill Gates’ salary has actually generally been pretty modest, reportedly a mere $650K back in 2005, and even the entry-level workers there are paid quite decently.
    Presumably then the bulk of his wealth has come through owning Microsoft stock. But he was able, early on, to purchase a particular percentage of that stock that may have made sense at the time, and continue to reap the dividends as though he was still personally responsible for that fraction of Microsoft’s wealth.
    It’s not clear to me that this is an example of the market fairly valuing the contribution of a major CEO.

  21. We reward those who can provide us with goods and service we value for their utility.

    JC – I’m not sure I understand how this works. Here’s why I’m confused.

    Imagine that I’m stranded in the desert. I walk for hours in the heat and — just before I’m about to pass out from dehydration — I find a roadhouse.

    I go up to the counter and buy a large bottle of water for $5. I guzzle it down. I sit for a while and then go up to the pay phone to call my family and tell them I’m not dead. It’s a long distance call so it costs $5. Then, because I’m feeling bored I buy a magazine to read. It also costs $5.

    The water saved my life, the phone call saved my family from the worry of thinking I was dead, and the magazine saved me from 45 minutes of boredom.

    Same prices but different utilities?

  22. I guess, Don, you would be grateful for competition, which prevents the merchant charging you your bottom dollar for that bottle. Which he does in the absence of competition, see eg the football :)

    And you should have called collect, which would have cost your family, and cost them more than it would have cost you to boot.

  23. Don, surely the problem with your example is that you are an extreme case in the example of the water and the phone call: most people who buy water are not on the edge of dehydration, and most people who make phone calls aren’t doing so to ensure their families can sleep at night. $5 represents the *average* value of the utility of a bottle of water, or a phone call, as judged by the market. If you had to, you would’ve paid much more of course.
    I’m sure you could likewise come up with a scenario where somebody needed the magazine to save their life, and a bottle of water purely because they wanted to make waterbombs.

  24. Don

    1.the minute you walk in the roadhouse presents a different set of circumstances/conditions than when you were in the wilderness. No longer are you suffering a dire shortage of water.

    this is why, it seems to me, you a little confused with the interplay of utility and scarcity. Goods such as water has great utility, but outside of the desert it is super abundant. It’s so super abundant that we send it down the drain and could in certain ways be seen as a free good.

    Moon dust is about as rare as hens teeth on earth at present but it’s utility is about as close to zero as one could get.

    2.Value also does not determine prices.

    3. Regarding your earlier comment where you mentioned virtue…..onne other thing that is I think needs clarification. The market does not reward virtue.

  25. NPOV – There are a number of problems with my example. But Patrick is right. I was grateful for competition. If the roadhouse guy had tried to charge me $1000 for the water I would have walked outside to where the dog was chained up, given him a pat and then lapped up the water in his bowl.

    But as it is the water only cost me $5. Now I’ve read the magazine and I’m bored again. So I ask the roadhouse guy if he can lend me a pair of scissors so I can cut out some pictures from the magazine and make a collage.

    He rummages around in a drawer and pulls out one half of a pair of scissors. He hands them to me and I say “That’s not a pair of scissors, it’s a knife.”

    “But it’s sharp,” he says.

    I’m still not sure I understand what utility is and how it differs from value (whatever that is) and how all this relates to prices.

    Can anyone explain this for me?

  26. Ummmm correction

    .one other thing that needs clarification.

    —————————

    N.

    Don presents a very good topic which I believe confuses lots of people. It’s the interplay of utility and scarcity and how these two concepts inter-relate to form prices.

    If my memory of economic history subjects serves me there were lots of discussions about this subject a few hundred years ago.

    I think there was some Italian monk who brought up the subject of scarcity/ utility and prices.

    He used the argument that a bag of Japanese sand would have been the only japanese sand in all of Italy at the time. However it’s utility was about as uselful as other sand and hence its price was about zero.

    Forget his name.

  27. Im still not sure I understand what utility is and how it differs from value (whatever that is) and how all this relates to prices.

    1.Utility is basically usefulness.

    2. Value – eg…. diamonds are valuable primarily because of their rarity while their utility is limited.

    3. Prices and the price mechanism help us sort all this out.

    Can’t recall who said this… but used the example of two blades.

    one blade was utility while another blade was scarity.Their intersection is prices.

  28. So it sounds something like

    value or price = “average utility” * scarcity

    would work as a general rule, with of course various exceptions. And it’s unlikely to be a strict multiplication, just some sort of function where increases in either value increase the total.

    But I’m not sure I see how scarcity was a big factor in Don’s example, other than the fact that for the desert trekker, water has a very high utility because it’s scarcity means that the body needs it more.

  29. N,
    There’s no such thing as “average utility”. It has to be specific. You can’t average the utility of water in the examples we’ve dealt with. It’s both impossible and futile.

    But Im not sure I see how scarcity was a big factor in Dons example

    Sure is in the desert. He didn’t have any until he arrived at the raodhouse when it became relatively abundant.

    water has a very high utility because its scarcity means that the body needs it more.

    What’s the point of this comment, N? I don’t see the context.

  30. Of course there’s such thing as average utility. For Don, the utility of a bottle of water was extremely high. For somebody wanting to play with waterbombs, it was pretty low. Don would’ve paid $100 for a bottle of water.
    Somebody wanting to play with waterbombs would probably only pay $1.
    $5 therefore is a price that represents the average utility of all possible customers.

    Scarcity is not an obvious factor in Don’s example because he’s not comparing the same product across two different scenarios, in one of which the product was scarce, whereas in the other it was not.

    If we change the example to, say, the fact that Don suddenly came down with a life-threatening fever, while living next door to a bottled water superstore, he would still value a life-saving bottle of water at much greater than the $5 charged for it.

  31. n,

    What’s the purpose of deriving average utility? What are you trying to get to?

    Why on earth would want to know the “average utility” of water in the Gobi desert and water in Canada?

  32. I’m simply pointing out that price reflects the average utility as judged by all likely customers – even though there will be individual customers that value the same product significantly more or less depending on various circumstances.

  33. Don’t know who the ‘virtuous’ are but, on average, the talented are rewarded in the market. Observe, for example, the very talented Meatloaf, the very talented Madonna, etc. these people are highly rewarded in the market. Of course, my own singing talent has gone entirely unrewarded, and that is Hayek’s point. No matter how much effort I put into my singing, the market will not reward it.

    Consider your good self, if there were no relationship (at all) between effort and reward why would you ever hone any skills that you may have? Why try to write better? Why undertake a PhD? Why read widely? Why think carefully?

    The fact is the talented are rewarded. Not ‘always’, and not ‘never’, but somewhere in between that is enough to encourage people with varying talents to try harder, to do better, to strive to improve themselves.

  34. NPOV said “Im simply pointing out that price reflects the average utility as judged by all likely customers”

    Prices are typically set by supply and demand although utility will obviously have an effect on demand.

    For example, for a product with no limits to supply the price will be roughly cost-of-production + profit, regardless of the utility to buyers.

    This is a big part of the reason that demand for oil has been relatively inelastic. For most of the past century, for most users, the utility obtained from oil has been much, much higher than the utility of the money needed to purchase that oil. Now that supply is limited, the price has had to rise until the utility of money required to purchase outweighs the utility of oil for marginal users.

  35. Sinclair – Well, surrendering the claim about virtue is a start.

    As for talent, there are at least three separate claims in play here:

    (1) If an individual improves their skills they will be able to command a higher income.

    (2) The distribution of market incomes mirrors the distribution of talent.

    (3) The distribution of market incomes mirrors the distribution of moral merit (ie the market gives people the income they deserve).

    With the right caveats claim (1) is hard to dispute. If an individual is able to develop skills for which there is unmet demand and reach a marketable standard then, all things being equal, they are likely to earn a higher income.

    Claim (2) is a lot more difficult to defend. To start with we need a single metric for talent. To test the claim we’d need to be able to compare and rank talents for painting, teaching, plumbing, computer game playing, torture, doing Meatloaf impersonations etc.

    I’m guessing that a mediocre plumber will generally earn more than an excellent Meatloaf impersonator or Tetris player.

    It seems to me that claim (2) requires you to defend something that looks a lot like the labour theory of value.

    Claim (3) seems just preposterous. Again we need a common metric — this time for moral merit. To test it you’ll need to rank school teachers, nurses, hedge fund managers, drug dealers, television personalities, Meatloaf impersonators etc.

    And it seems to me that the claim that markets give people the incomes they deserve requires something more than having the rankings of merit and income match up. If one person earns 1000 times what another person does then we’d expect them to be 1000 times more deserving.

    ***

    So just to be clear, we’re not arguing about whether markets encourage people to develop skills that lead to results other people find useful.

  36. I have nothing to say about claim 3 (except teachers’ salaries are determined by govenrnment and not the market) or moral value etc. Those types of argument (popular as they are) are really nonsense. That, however, is not to suggest that morals are themselves not valuable. The work ethic and values that promote honesty etc. are valuable in any (sustainable) society. The excitement, I think, is around claim 2.

    The distribution of market income does not mirror the distribution of talent. That we can agree on. Everything else being equal the correlation between the two is statistically significantly greater than zero, but (always) less than one. It is also economically significant (in the Dierdre McCloskey sense) but still less than one. Useful debate revolves around how much less than one. My view is that the greater the level of economic freedom the more likely that correlation will be closer to one. The important point is that the correlation is ot zero or negative (in that type of economy there would be very perverse incentives – historically that may have been the case).

    Hayek’s point is that even if one had a (marketable) skill and you worked hard at developing/maintaining/improving that skill there is still no guarantee of success.

  37. XT – I’d say supply and demand factors constrain the possible price range. But if the average consumer judges a magazine to have a utility of around $5, then retailers will sell it for that, even if they could make a good profit selling it at $3 – doing so won’t increase sales*. And if production costs go up, meaning that it can’t be sold at $5 profitably, then raising the price of the magazine to say, $6, is going to result in less customers, because only a subset of the potential market values the utility of the magazine that highly.

    * I was reading yesterday that supermarkets sell toothbrushes that wholesale around 20c each for upwards of $5. Presumably retailers have determined that consumers are happy enough to pay this much that there’s no competitive benefit in selling them for much cheaper.

  38. But if the average consumer judges a magazine to have a utility of around $5, then retailers will sell it for that, even if they could make a good profit selling it at $3 – doing so wont increase sales*

    Your toothbrush may be one example – but generally, competition does reduce prices, and significantly. The best example is Wal-mart, who have made billions simply by focusing on being the cheapest, the best counter-example is France and Belgium, where they aren’t allowed to compete (in theory, partly because prices should be lower if there are lots of options, which options are sustained by, mmm, artificially high prices – go figure). Supermarket prices there are horrendously expensive.

    This effect is not attributable, as you imply, to people’s changing perception of utility, except in that people’s perception of utility changes as a result of competition lowering prices.

  39. Hmm, well I was in Paris a month or so go, and the prices there generally seemed reasonable – certainly cheaper than London. And I noted previously that prices in U.S. supermarkets aren’t especially lower than they are here – some things are much cheaper (wine) and some much more expensive (cream) and the final price of a weekly shop seemed to be much the same.

    And what do you mean that supermarkets in France aren’t allowed to compete?

  40. FWIW, I would think competition at the business-to-business level is far more powerful than competition at the business-to-consumer end. Businesses are always looking to minimize costs in a way that typical consumers often don’t bother with, simply because a small amount of effort can save very significant amounts of money for a business, whereas for a consumer who buys a toothbrush every 6 months, the effort required to find a cheaper retailer isn’t worth it.
    No doubt consumers would prefer to pay less for their toothbrushes, but the convenience of being able to pick on up when doing the weekly shop at your local supermarket beats any saving you might get from bargain hunting elsewhere.

    Of course, for pricier goods, this is quite different, and I’d agree that for, e.g. cars, competition would be expected to have fairly dramatic effects on price.
    It’s worth spending the day driving around to find the best bargain when it could save you $5000 or more.

  41. Sinclair – This makes me think of a story …

    ***

    THE VILLAGE FRUIT SHOP

    I’m having some friends over to dinner tonight so I walk down to the fruit shop to buy some strawberries for dessert. But when I pick up a punnet and look at the price I’m enraged:

    ME: How can these strawberries be worth $8 a punnet?

    FRUIT SHOP OWNER: They’re very good tasting strawberries.

    ME: This doesn’t seem fair.

    FSO: My prices are always fair. All things being equal, better tasting fruit costs more than worse tasting fruit. Otherwise why would farmers bother growing good tasting fruit?

    ME: But the strawberries cost 12 times as much as the grapes. You’re not telling me that they taste 12 times as good are you?

    FSO: Fine. How many kilos of grapes do you want?

    ME: I don’t want grapes. I want strawberries.

    FSO: There you go.

    ME: Look. Three months ago you were selling a punnet of strawberries for $4. Are you saying they taste twice as good now?

    FSO: I said ‘all things being equal’. This isn’t an exact thing.

    ME: So how come they’re more expensive now?

    FSO: Strawberries are seasonal. Did you want some?

    ***

    Arguing about (2) is pointless for exactly the same reason.

  42. And what do you mean that supermarkets in France arent allowed to compete?

    They aren’t allowed to sell below cost, they aren’t to allowed to negotiate favourable pricing from suppliers (ie the price at which Danone sells to Carrefour must be the same as the price at which it sells to the Petit Casino) they aren’t allowed to have sales without prefectural approval they aren’t allowed to practice ‘predatory pricing’ (to the extent not already covered) which basically means in practice they must sell each item at an absorbed cost.

    And, OK, prices might be cheaper than London, although I don’t know if you converted both into AUD or simply ‘felt’ the differences. I am very sure that they are much higher than here, and much higher than Spain, and much higher than Germany, and higher than Holland, and many items are higher than in Switzerland (although that one cuts both ways).

  43. (

    2) The distribution of market incomes mirrors the distribution of talent.

    Arguing about (2) is pointless for exactly the same reason

    I really don’t get your point, Don.

  44. Don
    I could imagine I’m a lot of things but a banana? That’s going a little too far isn’t it?

    You’re now implying that people can’t forecast short term price movments and what markets are going to do next. Yea, but that’s hardly new.

    It seems you’re trying your best to argue markets aren’t perfect. That’s true they aren’t. The only thing is Don, there isn’t anything better that offers allocative efficiency. However I am happy to admit I’m wrong. So if you can think of a better way I’d be happy to hear it.

  45. He has mentioned getting rid of the prefectural advertising, but whilst he appears to genuinely understand the need for greater competition, he sometimes appears to have a pretty economically illiterate pro-inefficient-small-business-support view of what that is.

    Maybe that is just political pragmatism, but if so, it looks like pragmatism become spinelessness. No wonder France’s newspapers feature an article along the lines of ‘Does France need a Margaret Thatcher’ every summer for the last several years!!

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

Notify me of followup comments via e-mail. You can also subscribe without commenting.