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UMass Amherst ECON 103 - Class 19 Is Okun right Fall 2014

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Slide 1Slide 2Slide 3Slide 4Is it fair that some have more than others?Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17We don’t need inequality to get growthSlide 19US has had very high marginal tax ratesWithout slowing income growthSlide 22Slide 23Slide 24Slide 25Slide 26Slide 27Slide 28Slide 29Slide 30Slide 31Slide 32Slide 33Slide 34Slide 35Slide 36Slide 37Slide 38Slide 39Slide 40Slide 41Slide 42Slide 43Who will care for us when we are sick, hurt, needySlide 45Slide 46Slide 47Remember to do Moodle QuizReal World Milo?Wrong edition!Is Okun Right?Must we tolerate inequality to maintain efficiency?13:12:43•Arthur Okun argues that equality reduces efficiency.•Empirically, there is little support for Okun’s argument.•Inequality reduces efficiency by fostering distrust. Equality can be efficient by promoting investments in human capital.13:12:43Is it fair that some have more than others?YES!•They deserve it as a reward to hard and unpleasant work!•We should give rewards to encourage people to work hardNO!Productivity comes from many sources, including society. •People are not rich because they work hard. More a matter of luck and manipulation of markets•Rewards are not needed to get people to be productive.•Rewards can encourage counterproductive behaviorMaybe our view depends on how much inequality is reward to work and how much is luck or due to political manipulation?Americans want a more equal distribution of incomehttp://www.theatlantic.com/business/archive/2012/08/americans-want-to-live-in-a-much-more-equal-country-they-just-dont-realize-it/260639/92% prefer “Equalden” to USA!If we are an egalitarian democracy,Why do we tolerate these disparities?Okun: we accept inequality to achieve more efficiency.We can reduce market inequality only in a “leaky bucket”He is at least partly wrong•Loss of work incentives – the rich don’t work because of taxes; the poor stop working because they can collect welfare.•Bureaucracy – unproductive government officials to collect taxes and supervise welfare.•Loss of incentives to be creative and take big risks to earn big rewards.13:12:43Americans were not the first to favor income redistribution.We make movies about it. 13:12:43Society, Okun says, has a production possibility frontier of efficiency and equalityMore of one will lead to less of the other.More equality comes at the cost of less efficiency.We buy more efficiency by giving the rich more and reducing equality.Okun: Even the poor will benefit from inequalityGreater income produced by incentives will trickle down to the poor.13:12:43How much leakage would you accept?If we took $100 from the richest person to give to the poor, how much loss would you accept?1.$95?2.$50?3.$20?4.$5?13:12:43Okun’s logicIf we reduce the penalty for poverty, we encourage the poor to stay poor rather than working hard and productively in the market.If we reduce the rewards for being rich, we reduce the incentive to work hard and productively.Also, redistribution creates a wasteful bureaucracy.13:12:43Okun: poverty is a spur to productivity, and opulence is a rewardThe lazy sleep on the streetHard work is rewarded with golden ice cream sundaes.13:12:43We design social policy to minimize the “costs” of equalityWe do little for those who “should” earn on their own.We do more to help the elderly and the disabled because we don’t expect them to work.13:12:43But Okun is wrongThere is no association between inequality and greater efficiency.13:12:43Not across countriesNor across US states.We don’t need inequality to get growth0.0 2.0 4.0 6.0 8.0 10.0 12.00.0%0.5%1.0%1.5%2.0%2.5%3.0%f(x) = − 0x + 0.02R² = 0.11Productivity Growth and Change in 1% share, 1977-2010Growth in 1% share 1977-2010Annual labor producitivity growth 1977-2010Costs to inequality! Higher productivity growth iwith slower growth in 1% shareWorldwide, increasing inequality (Gini) lowers growth while redistribution increases it!http://www.demos.org/blog/2/27/14/imf-reducing-inequality-transfers-increases-growthUS has had very high marginal tax rates 13:12:43http://paul.kedrosky.com/archives/2011/07/top-u-s-marginal-tax-rates-over-time.htmlWithout slowing income growth 13:12:4392% 70% 50% 38% 34% 30%1.0%1.2%1.4%1.6%1.8%2.0%2.2%2.4%2.6%f(x) = − 0x + 0.02R² = 0.3Highest Marginal Tax RatePercapita income growth rateLower tax rates associated with slower per capita in-come growthOkun is wrong: much inequality is due to luck, not talent or work•A third of the Forbes 400 were born into the super rich–Almost all of the rest were born rich•Virtually all of great fortunes come from owning an asset that appreciates in value more than the rest of the market anticipated–Real estate–Commodities–Equity in a companyWhy is Okun wrong: trustCommunities with wide inequality have more crime and higher transactions costs to police and guard possessions.They suffer inefficiency of crime, insecurity, and lawyers.13:12:43Okun is wrong: Inequality is expensive. We pay with crime and distrust.Trust is a great economic asset. It allows us to avoid expensive litigation and crime. Cooperation trumps conflict.The United States has the least equal distribution of income and the highest incarceration rateInequality raises rewards for theft, and the penalty for poverty.13:12:44Places with inequality put more people in jailhttp://economix.blogs.nytimes.com/2009/03/12/crime-and-punishment-some-costs-of-inequality/#more-223313:12:44There are costs to inequality: more differential means more to defend.Costs to InequalityViolence is greater in societies with less equality.Why participate in the market if you can do better by engaging in theft or fraud?13:12:44Prisons are expensive. So are lawyers.Especially these.13:12:4413:12:43It costs money to catch criminals. It helps if advertisers pay for it!Some may not be worth it13:12:44Crime is expensive.So are burgler alarms.13:12:44And strange defenses13:12:44We all benefit from living in a society where others are healthy, trust-worthy, honest, and well-educatedIt is convenient not to need body guards.13:12:44Economic growth depends on cooperationThe problem of economic growth is to tap the ideas of large numbers of people.No one is smart enough to do it by him or herself.Capitalism is good at this compared with slavery or feudalism.But cooperation requires trust and commitment to others; it is undermined by


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