A Missed Opportunity for Serious Debate

by Edward Conard
September 22, 2016

Richard Epstein, a libertarian law professor, reviewed my new book, “The Upside of Inequality: How Good Intentions Undermine the Middle Class“, for the WSJ. Unfortunately, Epstein misses the central point of the book — that capital no longer limits growth in today’s knowledge-based economy. Today, properly trained talent and the economy’s capacity and willingness to bear risk drive growth while savings sit unused despite near-zero interest rates. This lack of understanding undermines his criticism of the book.

For example, Epstein contends that the book claims that taxing success “diverts resources,” implying that savings constrain growth. In fact, the book contends that taxing success slows growth by gradually dampening risk-taking. Nor does Epstein acknowledge that companies like Google and Facebook can now scale to economy-wide success with little need for capital or investors. This allows successful innovators to capture a larger share of the value they create and reduces the need for savings.

Ultimately, this misunderstanding leads Epstein to claim that the book “never explains why trade imbalances are bad…given that imbalances only mean that other nations are lending us money to create more goods and services rather than buying them directly.” The book repeatedly explains why unused savings slow growth. It’s a central issue in economics, especially now after eight years of tepid growth.

While Epstein is correct that surplus exporters lend savings to America rather than buy products that employ Americans, he overlooks the fact that the savings will sit unused unless someone bears the risk of borrowing and spending those savings. When properly trained talent and risk-taking constrain growth, risk-averse savings sit unused even at near-zero interest rates. When savings sit unused, trade deficits (but not trade) slow growth and export jobs. Epstein simply doesn’t acknowledge the critical difference between constrained and unconstrained resources. After eight years of mediocre growth, America doesn’t need more savings; we need more jobs and higher wages.

Epstein also complains that the book “fails to identify what combination of taxes, import quotas and domestic subsidies could eliminate international trade imbalances without disrupting the entire system of global exchange.” The book makes a straightforward recommendation for balancing trade: issue a dollar’s worth of import licenses for every dollar of exports and let the licenses trade freely. This balances trade without taxing or restricting it, except when trade partners use their unneeded savings to export our employment as many do. America has plenty of competitive products for free traders to buy. Unfortunately, Epstein conflates his defense of trade deficits with logical arguments for trade, as if we couldn’t capture virtually all of the benefits of trade without suffering the costs of deficits. It’s okay to debate the proposal but unfair to write that the book never made one.

Epstein says his “deepest disappointment” with the book “stems from the thinness of its reform proposals, beyond lowering…taxes.” Ironically, the book argues that cutting taxes without cutting government spending does little to accelerate growth. Tax cuts produce fiscal deficits because faster growth requires decades of successful risk-taking to gradually build the capabilities needed for faster growth — the synergistic communities of experts in Silicon Valley, for example. These capabilities increase the payoffs and certainty for risk-taking, which motivate increased risk-taking. This positive feedback loop has taken hold in America, but less so elsewhere. Yet, Epstein only credits reduced regulation for the success of America’s high-tech industry—a very narrow view.

Rather than pretending that rapid growth will offset tax cuts, the book recommends recruiting millions of ultra-high-skilled immigrants and gradually redirecting taxpayer subsidies away from college majors where the supply far exceeds demand to accelerate growth. It also recommends lowering the corporate tax rate to 15% to make America a more attractive base for international corporations to conduct business but also offsetting lost revenues to minimize deficits by raising the personal capital gains rate. To reduce government spending, the book recommends zeroing middle-class taxes and charging taxpayers for the full cost of the government services they consume. This would create incentives for less, rather than more, spending. Rather than being “too thin,” these proposals may be too far-reaching to gain consensus among divided lawmakers.

‘The Upside of Inequality’ includes many other proposals. For example, the chapter on education cites research which concludes that only tutoring-intensive, no-excuses charter schools have proven effective at raising the test scores of low-scoring students‎.‎ The book recommends expanding the supply of these schools to meet the demand of parents. The book also calls for a constitutional amendment banning tenure in recognition of the fact that while the overwhelming majority of teachers work as effectively as they can, teachers’ unions prevent schools from firing the worst teachers.

Epstein criticizes the book for “inexcusably trash[ing] the entire charter-school movement by insisting that the ‘selection-effect’ from ambitious parent who apply to charter schools drives their performance,” and admonishes, “Tell that to the thousands of disappointed parents who are consigned to the public-school monopoly by powerful unions that resist every reform.” He doesn’t acknowledge that credible charter school research separates school effects from selection bias — a mistake that advocates unfamiliar with the literature frequently make, but one the book is careful not to make. These studies recognize that demanding schools have only proven to be effective when parents or guardians let their low-scoring children attend and so they are unlikely to be a panacea for more than a subset of students.

Epstein opposes some of the book’s arguments on ideological grounds, but never debates the arguments on their own terms. He never acknowledges the main thesis of the book, that capital no longer constrains growth, or the proposals to help economic policy adapt and accelerate slow growth given these new constraints. In effect, Epstein argues that the book’s proposals would be unneeded if savings still constrained growth. It’s a missed opportunity for serious debate.