It’s a rare pleasure when a book on economic theory discusses how our economyactually works. Edward Conard’s The Upside of Inequality is one of those rare books. Conard refreshingly places the credit for economic prosperity where it belongs: On the willingness of innovators, entrepreneurs and investors to assume risk and on the availability of properly trained talent to turn risk into success.
During the Obama presidency, the economic discussion focused on government directed fiscal and monetary policy intended to generate economic growth by creating demand and increasing consumer spending. With wages stagnating and GDP hovering at 2 percent since the recession ended in June of 2009, this Keynesian demand side approach to economic growth obviously failed.
To explain this failure, prominent Keynesian economists have attempted to argue either that President Obama’s nearly $1 trillion dollar economic stimulus was too small (so it failed to create sufficient demand) or because the much criticized “one percent” took too much of the economic pie (leaving too little for working and middle class Americans). Ignoring both history and common sense, these economists continue to advocate for increased government spending, regulation and income redistribution as the path to prosperity.
In The Upside of Inequality, Conard brings reality to the ivory tower, convincingly upending Keynesian demand side theory by pointing out that investors rarely wait for demand. Rather, they wait for innovative ideas “that create their own demand” (like iPhones, Amazon, Uber) and the properly trained talent needed to commercialize those ideas. It’s the competition between innovators that creates prosperity, not “misguided government policies”. This is particularly so as we move from a capital intensive manufacturing based economy to a knowledge intensive innovation driven economy.
As Conard points out, “[s]uccess bubbles up from a large sea of failures”, and the possibility of large returns creates the incentive to take the risks necessary to produce those successes. While these returns increase the wealth of those who succeed (think Steve Jobs or Jeff Bezos), success also accelerates economic growth and prosperity for both working and middle class Americans.
Mistakenly blaming stagnating wages on the success of the one percent leaves the true causes unaddressed. Writing before the 2016 election, Conard recognized the significant impact of free trade and low skilled immigration on the economic stress facing working and middle class Americans. As the success of President Trump’s campaign demonstrated, voters intuitively agreed.
Conard acknowledges that trade with low wage economies reduces the cost of goods. If trade failed to lower the cost of goods more than it lowered the cost of labor, it would be more economically rational to manufacture goods domestically.
However, he points out that while everyone benefits from lower cost goods, lesser skilled workers suffer all the detriment of producing those benefits through the loss of jobs and the downward pressure on wages. Trade deficits export jobs to lower wage offshore workers increasing the available domestic workforce without increasing the demand for labor. Attempts to compete with low cost off shore labor by increasing productivity (through means such as automation) further reduce the demand for workers. “As a result, trade lowers the relative incomes of the middle and working classes” while the rich, retirees and non-working poor “enjoy lower priced goods without suffering lower wages.”
As Conard notes, the displaced workers depend on “entrepreneurial risk takers, properly trained talent and investors to commercialize new courses of employment” to replace the jobs they’ve lost through trade. So, attempts to reduce income inequality by attacking the incentives that encourage risk taking and investment actually constrain job growth to the disadvantage of the very workers the redistributionists claim to be protecting.
Conard also convincingly describes how an influx of low skilled immigrants exacerbates the problem. Lesser skilled domestic workers must compete with low skilled immigrants. That lowers wages as employees compete with each other for a limited number of jobs. As with trade, while the reduced labor costs result in lower prices for all consumers, the downside of lower wages primarily impacts the working and middle classes. Any employment gains chiefly benefit the immigrants.
In short, Conard aptly demonstrates how free trade, massive trade deficits and excessive low skilled immigration have created “a near unlimited supply of lesser skilled labor” competing for a finite number of jobs, hobbling working and middle class wage gains. Trade and immigration “spread a limited amount of income over a greater number of workers,” slowing wage growth.
Fair trade policies designed to reduce our massive trade deficits would help. We need trade, but we don’t need massive trade deficits. Immigration policies honed towards the needs of our economy that prioritized emigrants based on their skills, rather than extended family ties, would reduce the negative consequences of what has essentially been a policy of open immigration.
But, Conard’s main point is that the “outsized success of America’s 1 percent has been the chief source of growth exerting upward pressure on domestic employment and wages.” Policies that empower entrepreneurs and investors – the one percent – to create more jobs are the solution, not the problem. We should encourage and praise this success rather than discouraging and taxing it.
The very arguments in support of taxing success are fundamentally flawed. According to Conard, in order to justify taxing success, the redistributionists must either “ignore or deny the motivational effects of higher payoffs for risk-taking.” By ignoring how people think and why they take risks, the redistributionists artificially reduce the projected downsides of higher taxes and make the case for redistribution appear better than it actually is.
As every business person knows, payoffs matter. High returns motivate risk takers in the first place, and it’s the risk takers and investors who generate economic growth creating jobs and increasing wages. “The success of the 1 percent is an asset, not a liability” as it puts upward pressure on both employment and wages.
Why then is the rise in income inequality so reviled? As it turns out, that may not be the case. A recent scholarly article at Nature.com titled “Why people prefer unequal societies” notes that, when asked about “the ideal distribution of wealth in their country”, people “actually prefer unequal societies.” Despite appearances to the contrary, they found “no evidence that people are bothered by economic inequality itself” but rather “are bothered by something that is often confounded with inequality: economic unfairness.”
Conard address this concern as well. While advocates of redistribution argue that “we can redistribute the success of the wealthiest without consequence because their success is unearned and comes at the expense of others,” the reality is that the most successful Americans are “entrepreneurs and innovators who earned their pay by persuading customers, not hierarchical superiors, to pay them more.” Economic unfairness rather than inequality constrains growth. As Conard notes “[i]f a country’s billionaires earned their success, the economy grows faster. If their success stems from political cronyism, it slows growth.”
Conard won’t convince everyone. But if your mind is still open to the possibility that America need not suffer economic stagnation and decline, The Upside of Inequality is well worth reading.