It's now thirty years since Sherwin Rosen published his piece on the Economics of Superstars, a theoretical argument that income rewards disproportionately the most talented or most charismatic in a field, with the ability to distribute services to customers the limitation in the generation of such rewards. At the time of writing that piece, Rosen probably didn't know of Bill Gates. Surely Rosen didn't anticipate the Internet era in 1981. Yet if you're looking for prescience among economists, there it is. Over time, as we've moved to the knowledge economy, an increasing amount of economic activity has become subject to a Rosen-style argument. And with that you have an economic theory of rising inequality, the huge wealth of the 0.1% a consequence of the communications and computing revolution.
Tyler Cowen jumps onto the Rosen bandwagon in his essay The Inequality that Matters. It is a piece that rubbed me the wrong way and here I will take issue with it. Cowen's conclusion is that indeed in the Financial Sector of the economy the huge wealth of the people at the top is troublesome, but elsewhere it is fine and what you'd like to see. And at the bottom of the income distribution, well, things aren't so bad really. It's a pretty picture, but I think he's wrong on both counts.
At the bottom of the distribution, there is this recent piece about the near poor, who together with the poor constitute one third of the entire population. Further, many of the near poor are in two-parent households and are white, full time workers. It's just that their jobs don't afford them much of an income. They live paycheck to paycheck, with essentially no margin for income disruption. Cowen uses a pejorative, "threshold earner," to characterize many low income people. Presumably, these people earn just up to a threshold and then choose to not work beyond that. If it were true, this would make low income a matter of choice and therefore not a source of public concern or public policy. The piece about the near poor, however, makes clear that the big issue is opportunities for such people to make a decent living. Many were middle class and have since slid into this more precarious state. Capitalism isn't doing well by these people, who are struggling to make it. In this sense capitalism is itself fragile. One can hope the problem is due to the business cycle and is not a long term structural issue. With the economy in the doldrums, it is hard to tell.
Cowen also misses the boat on income generation at the high end of the distribution. He points out first that pre-tax income was far more unequal under Bush than it was thirty years earlier. So it can't be the Bush tax cuts that explain this inequality. He next points out next in comparing the incomes of J.K. Rowling and Tiger Woods in the recent past to the incomes of Charles Dickens and Arnold Palmer in their hedays, well it's really no comparison. The incomes of the former swamp the incomes of the latter. This is perfectly in accord with Rosen, so all is good in the world.
To determine health of the system, however, the point is not to look at the incomes of the superstars themselves, but rather look at the superstar wannabes. What is their condition? Rosen had a wry wit that showed up even in his published work. He points out one market characterized by superstars is the textbook market for Economic Principles. There are many competitor textbooks that vie for the few top slots, and several of those competitor books are nearly as good as the market leaders and perhaps even better. But they haven't gotten a broad adoption, which as things viral goes, begats further broad adoption. Some economists devote their scarce time and energy to write these alternative texts, on the off chance that theirs will break through into the top echelon. This marks a healthy ecosystem. There are some dominant leaders but lots of competition to replace them. Economists would call this a case where there are no or only very few entry barriers to entry.
Now think of stories about how Bill Gates or Steve Jobs or Mark Zuckerberg got started. Each was passionate about his enterprise from the get go. The very early work involved only a few compatriots, who had the same vision. These were essentially skunkwork projects. Great success emerging out of a skunkworks background is part of the American folklore. For example, see the movie Tucker for a Hollywood rendition of the Horatio Alger story. It means the opportunity is available to anyone. All that is needed is the core idea, the will to succeed, and some luck.
The notion that luck plays a role in determining the winner is part and parcel of Darwin's Theory of Evolution. Stephen Jay Gould tells us that most of us were taught the wrong metaphor about evolution, thinking of it as a tree trunk. Instead, evolution looks like a bush with many branches, each viable. Then natural selection comes along and picks one of the branches in a way we couldn't have foreseen in advance. Recently, Robert Frank has been touting Darwin over Adam Smith as the rightful father of economics, because Darwin's approach to competition is more robust and seems a better predictor of actuality. The key difference is that Darwin's approach allows for successful mutations that provide individual advantage but that are threatening to the species (and perhaps to the entire ecosystem). Frank provides us with an example from nature. Of the species elk, the males have horns that are too large, the burden in carrying them greater than the advantage they afford against other predators. But in head to head competition with other male elk, they are a benefit and hence it is a trait selected for in Darwinian competition.
Cowen does find elk-horn-like competition in financial markets. But he doesn't even deign to consider that possibility elsewhere in the economy. Are there other sectors of the economy where the big guys, winners in earlier competitions, beat up on the little guys? For example, do the big guys aim to to rig the next game to played so they reap the spoils from victory while letting others get to hold the bag when the approach doesn't pan out? This is the thesis of Winner Takes All Politics, yet Cowen will have none of Hacker and Pierson's work. Nor does Cowen discuss that with bigger prizes for the superstars, winners in previous competitions aim to win the next competition not by a skunkworks approach or a diversity of various skunkworks projects, but rather by making a big splash, one blockbuster after another. The Right hates when government does this, because government doesn't know how to pick winners. But they are quite content to pick winners themselves, in essence ignoring the essential role luck plays.
Yet the argument for what drives inequality is not sufficient to make Frank's point about species threatening but successful mutations. One needs to make a further argument that what we're seeing is a negative sum game. Such an argument would be of the form that the big guys are crowding out the little guys, raising the costs of getting into the game for them. Is there evidence of that sort too? Yes, there is. There is credit rationing now, especially for small business loans. It means many new ventures can't get to first base. This too makes the economy more fragile. Again one hopes that it is only business cycle problem and that credit will become more readily available to small business when the economy rebounds. But one wonders if this will be a lingering problem. The irony is that there is a lot of cash in the system. Who holds the cash? The big guys do.
My view is that capitalism has gotten much more brittle and short sighted over the last thirty years. Many people who are very good capitalists don't see the harm to the system they have caused by their own success. (Mitt Romney comes to mind here with his work for Bain Capital.) Many people have become very good at playing the game. There are fewer who seem to be able to think through whether it is the right game to be playing. That's the question to be asking.