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Professor Samuelson on Income and Tolerance

December 30, 2008

Tags Free MarketsInterventionismOther Schools of Thought

In a recent editorial for Spiegel Online, Paul Samuelson claims that markets

cannot regulate themselves, either micro-economically or macro-economically. Wherever tried they systematically breed intolerable inequalities. And instead of such inequality being the necessary price to encourage dynamic progress via technological and managerial innovations, it instead breeds dysfunctional shortfalls in what economists call "total factor productivity."

Why do markets fail in this regard?

Convincing proof of these points can be found in the deterioration in the US from 2001 to 2008. As CEO pay rose respective to median employee pay — from a more normal 40 to 1 ratio up to and beyond 400 to 1 — industrial progress deteriorated rather than accelerated.

There are two problems with Professor Samuelson's analysis. First, it is strictly empirical in nature. Second, it is defective even as empirical analysis. The idea that we can arrive at general conclusions regarding the need for egalitarian income distribution by observing income and industrial progress during the past two presidential administrations simply is not warranted. Samuelson established his reputation as an economist by constructing rather elaborate theoretical models, but he is now willing to render final verdicts on capitalism based on only a few empirical observations. Of course, there are those who criticize his theoretical models, but in this case Samuelson has rendered himself immune to such criticism; one cannot criticize a nonexistent theory. We can, however, recognize that his anecdotal example is unsupported by theory. The example that he cites proves nothing, even if we accept this example as valid.

The example that Professor Samuelson cites as evidence of intolerable inequality in free-market capitalism is also invalid. America did not have laissez-faire in 2001. It is true that spending was restrained during the late 1990s. It is also true that some tariff rates have come down in the past two decades. However, there has been an upward trend in federal regulation. Dawson (2007) has found that federal regulation tripled since 1975. Federal regulation did shrink for a brief period in the late 1990s, but it increased during the Bush administration. Also, federal spending increased dramatically during the Bush years. This data invalidates the Bush years as an example of the laissez-faire capitalism that Samuelson finds objectionable. On the contrary, the data in question indicate that increased regulation and spending by the federal government "breeds dysfunctional shortfalls in what economists call total-factor productivity."

It is also worth noting that many studies find that a higher degree of economic freedom correlates with greater income equality. Of course, there are other studies indicating that economic freedom correlates with greater income inequality. The statistics on this subject are not 100% clear. How, then, can Samuelson make the claim that free markets generate inequality? He needs to become better acquainted with the empirical findings on this subject.

Finally, Samuelson makes a separate claim that the income inequality is intolerable. It would be more accurate to say that he finds intolerable the income inequality that may or may not stem from laissez-faire. This is his opinion, or to be more precise, his value judgment. There is no reason why people cannot tolerate income inequality. Animosity towards the wealthy is the product of how we perceive economic relations. The lack of theoretical analysis in Samuelson's recent comment does not hide the fact that he adheres to a view that high incomes are somehow undeserved or a drag on economic performance.

 The Road to Serfdom by Hayek]

$15

There are good reasons to believe that some high incomes are well deserved, and that other incomes are not. For example, many American accountants have reaped greater incomes in the wake of the Sarbanes-Oxley regulation. The costs of Sarbanes-Oxley are a net loss for the US economy. It also seems likely that this regulation has increased American income inequality. In contrast, there are many examples of entrepreneurs earning fortunes by promoting economic efficiency through innovation and the more efficient organization of production.

Professor Samuelson has, in this case, misinterpreted an insufficiently small set of data to arrive at conclusions that square only with his own personal value judgments. He claims that his intellectual opponents (F.A. Hayek and Milton Friedman) give bad advice when they promote laissez-faire, but given the poor quality of the reasoning behind his remarks we should doubt his advice, not theirs.

D.W. MacKenzie teaches economics at the Coast Guard Academy. The views expressed in this paper do not represent the official views of the Coast Guard. Comment on the blog.

Sources

Dawson, J., "Regulation and the Macroeconomy," Kyklos, Blackwell Publishing, vol. 60(1), pp. 15–36, 02, 2007.

Hayek, F.A., The Road to Serfdom, 1944.

Friedman, Milton, Capitalism and Freedom, 1962.

Samuelson, Paul Anthony, "The Dynamic Moving Center," Spiegel International Online, November 25th, 2008.


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