Inequality and Risk: Starting Points for a Meaningful Conversation

by: Modeled Behavior

By Karl Smith

I’ll give Will Wilkinson this, he knows how to start a conversation. By my count there are now at least four stunningly good essays stemming from his latest edition of Cato Unbound.

There is Will’s lead essay

The responses by Lane Kenworthy and John Nye

And now Mike Konczal joins in.

From Mike

A lot of these inequality studies are carried out by economists, so it is natural to their theories to look at consumption. That’s all people are at bottom in the theory – Robinson Crusoe sitting alone on his island, waiting for some coconuts to grow so he can eat them.

I prefer to look at individuals less as eating machines and more as firms, firms engaged in the neoliberal entrepreneurial business of of leading their lives. Here we can brings some additional techniques, ones that would never look just at the owners assets, since they need to be match by his liabilities. Alternatively, if we look at the rewards, we need to look at the risks. And by any measure, the risks and liabilities of running a middle-class family firm have skyrocketed.

This is a startling important point that gets overlooked. Economists breathed a collective sigh of relief when we saw data showing that GDP really does make people happier.

However, what if all that’s really going on is that the probability of very bad events is going down. That is, the richer you are the less likely your child is to starve to death, the less likely you are to find yourself with no home, the less likely you are to be trapped in an abusive family. These bad things go down and happiness goes up.

In other words Crusoe is happy when his coconut stockpile increases not because he actually going to eat 50,000 coconuts but because implicitly the probability of any series of bad events leaving him with no coconuts or only rotten coconuts goes down.

Let me be clear about what I think we’re saying here. It’s not simply that there is some reservation level of consumption and as people get further from it they are better off. It is that there are a whole range of bad things that could happen to you and higher income gives you the ability to self-insure against more and more of those things.

This can go pretty far. The flat screen and DVD collection insures you against boredom. The night of the town insures you against an unhappy mate. Lots of what we think of as happiness from consumption might simply be freedom from worry. In this sense income is not merely an input to consumption, it is a substitute for consumption. We should demand income in and of itself.

Mind Dump Follows

Thinking out loud here but there is of course is the desire for status. So perhaps we are thinking of a basic two good world where there is security and status. What we think of as consumption / income is an input in these two goods but its not the only input.

As income and consumption rises we should expect that the marginal utility of status should also rise. However, depending on the nature of the status function it could be the case that most people will be in a low status position. That there is an inherent pyramid.

In this case it seems intuitively that there should be an income level that maximizes happiness. Beyond that increases in security are overwhelmed by unfulfilled desire for status.

Moreover, it follows naturally that constraining status competitions to areas that do not undermine security will be welfare enhancing. That is, there is a prisoner’s dilemma in economic risk.

We would both prefer a world in which there was very little risk. However, since risk brings on average a higher returns it means that if I am the only player not taking risks I am all but guaranteed to have lower status. Thus I must take risk. We all face this incentive and so we choose a risky but suboptimal world.

This might help us answer why it is that income inequality bother us but inequality of looks and personality does not. I can take risks to increase my income. This encourages you to take risks and is welfare defeating.

Traditionally I could not take risks to improve my looks. However, it is worth noting that in cases where one can there seems to be social concern. Dangerous diet, weight loss procedures, radical plastic surgery. All seem to induce not only concern but anger at the people doing it.

This fits with our model that the problem with inequality is that it encourages risk taking.

Like Mike and I very interested in hearing Will’s comments on this and I am sufficiently interested in the topic to devote some serious time and energy to exploring the answer if either of them are up for it.