Too Much Inequality? Time to Move Toward Optimal Inequality?

(Updated September 2023)

Krugman (2022) in the New York Times reminded me of what Adam Smith had to say about the matter of inequality, and, notice, I am talking here about inequality not redistribution. Krugman (2022) also points to the Realtime Inequality simulator developed by ,Thomas Blanchet, ,Emmanuel Saez, ,Gabriel Zucman, Department of Economics, at the University of California- Berkeley. The inequality in the US is unprecedented, and, needs to be dealt with. Also see Krugman, 2023, on the "yacht indicator"... mega-yachts in vogue among the mega-rich, like in the Guilded Age: Time to bring back some version of The New Deal Order that tempered the excesses of that Age. It is time to seek an Optimal Inequality, as Dual Interest Theory in Metaeconomics makes clear.

It all reminded me to go back for another look at Rasmussen (2016b), who points to Adam Smith. As made clear in Rasmussen (2016a; 2016b), and, the point is also made in Lynne (2020, Chapters 7 and 14), that Adam Smith saw the need to deal with inequality in order to achieve happiness, peace (reduce the political economic chaos), and, yes, achieve economic efficiency. In thinking about income and wealth inequality, a look into what Adam Smith had in mind is revealed in the following quotes highlighted in Roberts (2014, p. 40), from The Theory of Moral Sentiments book, Smith (1759/1790):

What so great happiness as to be beloved, and to know that we deserve to be beloved? What so great misery as to be hated, and know we deserve to be hated?

Man naturally desires, not only to be loved, but to be lovely.

Using Dual Interest Theory (DIT) in Metaeconomics (Lynne 2020)

First, to be beloved, one must avoid maximizing self-interest only on path 0G. Yet, to be beloved is served by being able to have a high income and, especially to be wealthy: People are generally in awe and otherwise display apparent love for people with high income, and especially the people who amass wealth, power, and influence. Scrooge is admired and loved for the acumen, the capability to have high income and make, and amass, wealth. Unfortunately, it can go too far, working to distort the sympathies (empathy with) favoring the people with high income and wealth, with disdain for the people with lower income and without wealth (Rasmussen 2016a, p. 342; 2016b; Sandel 2020).

Second, path 0G (and in the extreme of extremes, the vertical axis) is to be avoided, as it can lead to being hated. It is especially important to ensure that a person really deserves the income and wealth, relating to the need to be lovely. To be lovely was to temper the excesses on path 0G and operate more toward the shared other-interest path 0M. To be lovely --- and to deserve to be beloved --- is about being humane, as in contributing to a humane capitalism, a humane Market Forum, and, a humane Other Forum in both Community and Government. And as Adam Smith clarified, it was to be motivated from within, the conscience at work, a person doing it without someone outside driving it. Path 0M was to considered and something closer to it sought by each person, freely chosen.

Scrooge Often Must Be Nudged, Encourage Some Tempering of the Excesses

Yet, in order to deal with inequality, sometimes Scrooge must be tempered (nudged) from the outside, by the Ghosts, nudging the conscience, representing something which the other (Cratchit, the Community) can go along with. Adam Smith fully understood how a person has a more primal tendency to operate too much on the arrogance of self-love, on self-interest only. And, when the nudging by the Ghosts fails, the Community as represented by Government may have to step in to temper the arrogance, temper (nudge if not outright regulation and control) the self-interest, to nudge paying higher wages (recognizing value V rather than always working to pay the survival price P in wages) and helping pay (tax T) substantively for the public goods. So, third, the matter is resolved --- peace (far less political chaos, a stable political economy), and happiness, as well as economic efficiency, all emerge --- on path 0Z, where one not only is a person beloved but deserving to be loved. And, intriguingly, economic efficiency on path 0Z requires substantive attention to value V and tax T, and not just price P: It is about good balance in the private & public-good, which also means finding the optimal inequality.

As the Roberts (2014) book would have it, How Adam Smith Can Change Your Life: An Unexpected Guide to Human Nature and Happiness, the guide is to temper the self-interest with doing the right thing, the good other-interest. The latter meant operating in the moral dimension, as sociologist Amitai Etzioni (1988) also identified, in The Moral Dimension: Toward a New Economics. Adam Smith not only understood what drove the making of wealth but the need to temper the making (and, especially the taking and keeping) process with the moral and ethical dimension.

It is summed up nicely by Ashraf, Camerer, and Loewenstein (2005, p. 142), pointing to Adam Smith as Behavioral Economist: “In short, Adam Smith’s world is not inhabited by dispassionate rational purely self-interested agents, but rather by multidimensional and realistic human beings.” Said multidimensional and realistic human beings also prefer optimal inequality, that which the other can go along with, i.e., that which fits in the ethical system giving context to making, taking, and keeping income and wealth.

And, Optimal Inequality is Not Redistribution (Although It Might Be Helped)

It is about paying higher wages and providing for more compensation over the entire spectrum of income and wealth, paid with less compensation and pay at the top. An especially obvious example comes from an ethics based look at CEO compensation. It is clear (empirical question which has been examined) that adequate incentive is in place for a CEO to bring talents into making a company more productive with something on the order of $30-40M in annual compensation. It is not necessary to provide $300-400M. Using the difference to make for higher pay at the bottom goes a long way to not only be adequately loved, but, to be lovely.

For a real world case in point, Dan Price, owner of Gravity Payments, cut a $1.1M annual draw on the company’s profits, and moved to a $70,000 minimum wage: See $70,000 Minimum Wage in the Metaeconomics Blog. The business has grown and prospered, as something more akin to value V --- what was actually being contributed, a kind of instrumental value V --- went to employees. In general, the massive wealth accumulated at the top by shareholders and owners of companies needs to be reduced, while still retaining adequate (but not extreme) incentives to make wealth. Providing for more reasonable (i.e., empathy based ethics reflecting the shared other-interest working to temper same) compensation over the entire spectrum of the labor and management levels of a company works far better in producing a humane capitalism. It may not have to be as drastic as in the Gravity Payments case, but it makes the point. Similar outcomes have been experienced in the pay and compensation in professional sports teams, like baseball and football. The highest performance (winning games, and happy players, fans) comes from keeping sufficient incentives at the top while not going to extremes in the difference in compensation.

And, when the top does not move money down the income and wealth ladder, what do? Well, Labor Unions become key, in working to nudge a more Optimal Inequality. It is about the Unions offsetting the inherent excesses at the top, and, well, Unions must also restrain own-self, too. It is about balance, and avoiding the excesses in both directions.

But, What is Really Going On, with Most US CEOs?

On the matter of what is driving CEOs, well, it seems Prudence only self-interest is to be encouraged and tolerated, and it especially started in said direction in the early-1970s.  As McCloskey (2006, p. 119; and, see Review of the book by Khachaturyan and Lynne 2010) makes clear:  “In our time the Prudence Only ethic has become: Maximize stockholder wealth, and by the way make sure that you as the CEO or CFO have a good chunk of it, and a little inside knowledge about its present value. You will find some ethicists in business schools arguing that the reason to be just or loving or temperate is precisely that it is prudent.”  Shock, to a MetaEcon.

McCloskey (2006, p. 119 ) continues:  “In a famous article Milton Friedman (in 1970) argued, as the title put it, that ‘the social responsibility of business is to increase its profits.’”  Shock, to a MetaEcon.   “But most people who have expressed shock  (MetaEcons’ all) or pleasure (Libertarians, a MetaEcon would point out) at Milton’s article have not noticed that he adds a side constraint to the manager’s fiduciary duty to the stockholders: ‘Make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.’”  Well, a little better. The problem, is Friedman apparently missed the memo which describes how laws get changed to not necessarily temper the excesses with the ethical custom that the other could go along with, writ large. Rather it comes down to hiring expensive lawyers and lobbyists to facilitate a narrowly shared ethic,  as in embedding the ethic of  taking and keeping the wealth (change the patent and tax laws, anyone) rather than creating it (Munger and Villarreal-Diaz, 2019, pointing to the inherent tendency to cronyism; Pistor 2019, pointing to the inherent tendency to change law so as to take and keep capital on the path to extreme inequality).

And, then it gets even a bit better, as reality sets in: McCloskey (2006, p. 120) points to how, drawing on a book coming out of managerial economics:    “ ‘Unethical behavior is neither consistent with value maximization nor employee self-interest’ … Wouldn’t that be nice, if it were true?” That would be nice.

And, on Prudence-only profit seeking, as McCloskey (2006, pp. 120-121) says:  “It’s a tough-minded, American idea. A study in 1999 by the Conference Board found that 64 percent of American codes of ethics in businesses are dominated by profits. By contrast 60 percent of the European codes are dominated by ‘values.’ When many years ago the Harvard Business School was given more than $20 million to study ethics, it initiated courses that collapsed the virtues into the one good of Prudence, the utility of “stakeholders.” Harvard has since then taught thoroughly all the virtue that money can buy.” Ouch.  

McCloskey (2006, p. 121) continues, and now to the MetaEcon, real progress is being made:  “The point is that (Adam) Smith got it right and the later economists and calculators have got it wrong. You can’t run on prudence and profit alone a family or a church or a community or even—and this is the surprising point—a capitalist economy.”  Absolutely.  The Prudence-based profit-only path 0G does not work. Said Prudence must be influenced by the Other Virtues, as in Temperence (especially), Courage, Justice, and, yes, even Hope, Faith, and Love.  That tempering is achieved on path 0Z, not on the self-interest only path 0G.

Summing Up

A Humane Capitalism as envisioned by Adam Smith recognized the essential need to not only be loved coming from adequate incentives to make wealth but also be lovely  made possible by everyone getting a reasonable piece of the action, not just the people at the top. A few of the top economists are starting to recognize it, and call it Humanomics, as in Smith (not Adam, although Adam would approve) and Wilson 2019, McCloskey 2021. And, we MetaEcon do, too: See Chapter 7 in Lynne 2020 for how Metaeconomics could be used to guide, and help evolve, a Humanomics. And, again, addressing Inequality is Not About Redistribution through higher tax T of people at the top, although it may be needed, if empathy-with downstream is not brought into play. Rather, Inequality is about ethical compensation across the whole spectrum, with people at the top who control the pay and compensation scales acting in empathy with the other downstream. It is about tempering the excesses with empathy while keeping incentives to make everyone rich.

Am reminded here of McCloskey and Carden 2020, Leave Me Alone and I’ll Make You Rich: How the Bourgeois Deal Enriched the World. Fine, on Leave You Alone, but as a MetaEcon makes clear, it comes with responsibility to temper the excesses with empathy, temper the arrogance of self-love, else Extreme Inequality sets in, with political (economic) chaos predictable: Look around. The Bourgeois Deal is based in, rests in, survives by, empathy: Stay tuned for a Substack Post on I’ll Make You Rich.

As Adam Smith says, it is essential for each person to “… humble the arrogance of …self-love, and bring it down to something which (the) other … can go along with (Smith, 1759/1790, loc 1714-1727).” It is about empathy-based ethics tempering ego, as confirmed in modern Behavioral and Neuroeconomics science: Smith got it correct. Ego-based extreme greed is not extremely good for anyone, and, ironically, especially not for the extremely greedy: Scrooge, anyone? Scrooge was not happy. And, writ large, Scroogism (path 0G) does not work: Humane Capitalism, a Humanomics (path 0Z) does. Adam Smith tried to teach us so. It is about tempering the excesses with the sentiments, the empathy-based ethics. The rest is commentary.

References

Ashraf, N., Camerer, C. F., and Lowenstein, G. "Adam Smith, Behavioral Economist." Journal of Economic Perspectives 19, 3 (2005): 131-145.

Etzioni, Amitai.  The Moral Dimension: Toward a New Economics. New York: Free Press, 1998.

Khachaturyan, Marianna and Lynne, Gary D. "Review of McCloskey, D. N. The Bourgeois Virtues:  Ethics for an Age of Commerce. Chicago, Il: The University of Chicago Press, 2006, 616 pp." Journal of Socio-Economics 39 (October 2010): 610-12.

Lynne, Gary D. Metaeconomics: Tempering Excessive Greed. Palgrave Advances in Behavioral Economics, John Tomer ed. New York: Palgrave Macmillan, 2020.

McCloskey, Deirdre N. The Bourgeois Virtues: Ethics for an Age of Commerce. Chicago: The University of Chicago Press, 2006.

McCloskey, Deidre Nansen and Carden, Art. Leave Me Alone and I’ll Make You Rich:  How the Bourgeois Deal Enriched the World. Chicago: The University of Chicago Press, 2020.

McCloskey, Deidre Nansen. Bettering Humanomics:  A New, and Old, Approach to Economic Science. Chicago: University of Chicago Press, 2021.

Munger, Michael C. and Villarreal-Diaz, Mario. "The Road to Crony Capitalism." Independent Review:  A Journal of Political Economy 23, 3(2019): 331-344.

Pistor, Katharina. The Code of Capital: How the Law Creates Wealth and Inequality Princeton, NJ: Princeton University Press, 2019.

Rasmussen, Dennis C. "Adam Smith on What is Wrong With Income Inequality." American Political Science Review 110, 2 (2016a): 342-352.

Rasmussen, Dennis C. “The Problem With Inequality, According to Adam Smith.” The Atlantic, June 9, 2016b.

Roberts, R.  How Adam Smith Can Change Your Life: An Unexpected Guide to Human Nature and Happiness. New York: Portfolio/Penguin, 2014.

Sandel, M. J.  The Tyranny of Merit: What's Become of the Common Good? Kindle ed. New York: Farrar, Straus, and Giroux, 2020.

Smith, Adam.  The Theory of Moral Sentiments, Introduction by Herbert W. Schneider digireads.com, 1759/1790.

Smith, Vernon L. and Bart J. Wilson. Humanomics:  Moral Sentiments and the Wealth of Nations for the Twenty-First Century. New York: Cambridge University Press, 2019.