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The Rising Tide

Issue Analysis

Title

The Rising Tide

Answering the Right Questions in the Inequality Debate

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In a companion paper, People Not Ratios: Why the Debate over Income Inequality Asks the Wrong Questions, we argue that many inequality activists have been asking and answering the wrong questions in their quest to help the poor. Instead of analyzing the mathematical ratios between high and low incomes, poor people are better served by higher living standards. This paper proposes a policy agenda to raise living standards for poor people around the world.

We begin by looking at two policies currently popular with many anti-poverty activists, and find them wanting: the minimum wage and expanded collective bargaining.

Minimum wages benefit some workers, but come with tradeoffs that hurt others. The bleak litany of tradeoffs includes, but is not limited to: firings; hour cuts; reduced or eliminated non-wage perks such as insurance, vacation days, and complimentary parking and meals; lower annual bonuses; and reduced purchasing power due to higher prices. Moreover, some workers are never hired in the first place, and these willing workers are disproportionately young and minority. No amount of wishing can make these unintended consequences go away. Intentions are not results.

Collective bargaining has a similar effect. Some workers benefit, but only at other workers’ expense. Just as corporations and public officials work to benefit themselves rather than consumers or the public, unions work to benefit their own members, not all workers. The benefits unions accrue for their members come at a cost to everybody else. Collective bargaining does not create new wealth. Rather, it transfers existing wealth away from consumers and non-union members—and in the case of government unions, away from taxpayers—toward unions and their members.

After analyzing these two misses, we look at hits: policies that actually do help the poor. This requires making an important distinction: absolute poverty versus relative poverty. Relative poverty looks at ratios—the pay differential between a CEO and her secretary, for example. Absolute poverty is concerned instead with people’s actual living standards—can the secretary afford decent housing and a good education for her children? Many poverty activists are so concerned with ratios and relative poverty that they forget about absolute poverty and quality of life. Fighting absolute poverty begins with two fundamentals. The first is an honest price system. The second is a framework of institutions that protect entrepreneurship, openness, and commerce.

There are several possible ways to institute an honest price system. In most countries, a central bank manages the local currency. It is important to bind these banks with predictable rules to prevent panic during a recession or a financial crisis. Our point is not so much which rule a central bank should adopt, but that it must have a rule in the first place, and follow it consistently. We discuss three possibilities.

One is the Taylor rule, which the U.S. Federal Reserve followed for the better part of the 1980s and 1990s, with good results. The Taylor rule raises interest rates when growth and inflation are high, and lowers them when growth and inflation are low. It can be summarized in a single equation, making it easy for central bankers to know how they are supposed to react to a given set of economic conditions.

The second possibility is nominal gross domestic product (NGDP) targeting. NGDP, also known as “current dollar GDP” or “chained dollar GDP,” is the Gross Domestic Product figure before being adjusted for inflation. If the NGDP goes up by 5 percent, then so does the money supply, in lockstep. It attempts to keep each dollar describing the same amount of wealth, which should result in more stable, predictable prices.

Third is the Friedman rule, named for economics Nobel Prize winner Milton Friedman. Under the Friedman rule, the central bank deflates the currency at the same rate as the prevailing interest rate on government bonds. The goal is to make people indifferent about whether they keep money in their wallet or in a savings account. That means people will make allocation decisions based on economic efficiency, not the vagaries of inflation.

Central banks around the world have poor records of currency management. As a result, private alternatives, mostly in the form of digital currencies, are beginning to emerge. But in many countries these are hampered by a gray-area legal status or even bans. Governments should affirm private alternatives’ legality—and legalize them where necessary. The general principle is to allow currencies to succeed or fail on their merits, depending on how well they serve people’s needs. At this writing, bitcoin is the most popular private currency. While we doubt bitcoin’s long-term viability because it is inherently deflationary, it has already done an enormous public service by popularizing the concept of digital currency and introducing blockchain technology to widespread use.

Open competition among digital currencies could help the poor by giving them honest currency they can use to start businesses, borrow and lend against, and invest. Many people cannot currently do these basic financial actions under centrally managed currency, owing to its uncertain long-term value and risks of devaluation, inflation, and other potential problems.

Removing obstacles to entrepreneurship is central to achieving certain goals to help the poor. These include affordable energy, access to capital for entrepreneurs, occupational licensing reform, greater government transparency, and institutional-level changes to the regulatory process. Reforms to achieve these goals have the added bonus of helping to reduce opportunities for governmental corruption.

Affordable energy improves almost every aspect of people’s lives, from cleaner home heating to more transportation options, which expands job opportunities and career choices. To the extent that governments hinder entrepreneurs’ access to capital, they keep their citizens from achieving prosperity. Governments should get out of the way. Access to capital enables entrepreneurs to start a business, which is a way for people to escape poverty while creating even more value for others, enabling them to escape poverty as well, in a virtuous cycle.

Even in a relatively free economy such as the U.S., nearly a third of workers need a license to practice their chosen occupation. Despite the usual consumer protection rationales, the actual effect of much occupational licensing is to restrict competition, raise consumer prices, and keep willing workers  unemployed.

Government corruption is a serious problem in many countries, and greater transparency and accountability could do much to lessen it. Transparency can take many forms, though we focus on regular mandated reports and disclosures about a government’s regulatory policies. If an entrepreneur is uncertain about whether he has to bribe an official to get a permit, or does not know what regulations might be coming down the pipeline, it can have a chilling effect, which hurts him and his would-be customers.

We conclude by tying our reform agenda back into the need for poverty activists to focus on people, not ratios.