Honest Wealth And Incentives

Two points, which aren't tightly related: Honest wealth, and incentives related to great wealth.

Honest Wealth

One of the criticism of great wealth is that it is "dishonest", in the sense that it is secured through criminal or tortious conduct, or that, more generally, it is obtained by exploiting the people from whom it was secured, or is made possible only through externalities imposed involuntarily upon others, or through consent to transactions that isn't fully voluntary.

The bumper sticker version is that "behind every great fortune is a great crime."

In contrast, "honest wealth" is wealth acquired in transactions in which the person who receives income as a result of a transaction creates something of value (net of externalities in the transaction, and with these externalities properly compensated), and receives only part of the wealth created in the transaction, resulting in a win-win which is agreed to in a fully voluntary manner.

Many critics of wealth inequality overestimate the extent to which great health is dishonest wealth. I certainly don't dispute that great wealth is sometimes mostly "dishonest" by this standard, and that the very wealthy often obtain at least some of their wealth dishonestly. And dishonest wealth is economically important. 

Climate change is mostly due to the externalities imposed upon the rest of the world by just a hundred companies (in all of economic history) which have mostly benefitted, collective, perhaps a hundred thousand families.

Most of the great wealth in the American South is attributable to a significant extent to two centuries of slavery.

But, far more of the wealth in 21st century America is honest wealth than its critics think.

A corollary of the notion of wealth acquired honestly is wealth used honestly, as opposed to use it for license to act wrongfully, or in order to corrupt the system.

But, the problems caused by, and the solutions for responding to, "dishonest wealth" (basically various forms of business regulation and anti-corruption measures and sliding scale punishments for wrongdoing) are different from those that interest me today, which are the problems intrinsic in even honest wealth used honestly.

Incentives

Completely setting aside the issues associated with dishonest wealth and dishonest uses of wealth, however, even great "honest wealth" is a problematic barrier to developing a more affluent and productive society, related to the incentives that it creates.

The 20th century included an 82 year long experiment in the Soviet Union, countries in its sphere of influence, China, and countries in its influence, with Soviet-style and Maoist-style communism, that was also attempted in many countries in the developing and undeveloped world. The Soviet Union, which was the first country to usher in Communism at a national scale, started doing so in 1917 and was dissolved in a collapse of that system, that even its top leader recognized, in 1989. 

China adopted Maoist Communism starting around 1945, and has never formally disavowed it. But China and other nations in its sphere of influence in Asia started adopting reforms sometime after the Cultural Revolution in the 1970s (after only a single generation) that adopted market-like and private property accepting reforms of Maoist Communism starting in the 1980s. China hasn't made Western capitalist style reforms of its economy in a manner that is doctrinally pure or particularly faithful to Western legal and economic mixed economy models. Its property rights are less absolute, for example. But its economy is certainly, in substance, more capitalist than communist now. 

Also, even in the respects that China's political economy differs from Western style mixed economies, those differences, while they often have antecedents in pre-Western Chinese ideas about law, about how individuals interact in large organizations, and about the proper role of the government in society, don't have a particularly egalitarian, Marxist flavor seeking to vindicate the well being of the ordinary person at the bottom of the economic pyramid.

There are a few countries outside the Soviet and Chinese spheres of influence that are still trying to make Communism work on an ideologically Marxist influenced basis, most notably, Cuba (which is functioning quite well) and Venezuela (which is in an economic shambles of near total collapse, aggravated by international sanctions and international business disinvestment in response to its policies). 

But, it is fair to say that for all practical intents and purposes, Communism is dead even in countries with one party or dictatorial rule like North Korea that initially put those regimes in place based upon a Communist ideology. The remaining one party and totalitarian states of the world that were originally Communist ideological projects are now just plain old authoritarian regimes, not that different in how they operate and ideology from pre-modern monarchies.

In the end, Communism, as applied in the real world by many countries sincerely trying to make it work, failed. To be fair, there were alternatives of anarchy and a complete lack of organized economic development that were worse still. Even at its worst in places like Albania, Communism was better for the average person than Somalia-style clan warlord dominated anarchy. Communism was undeniably worse that modern Western mixed economy capitalism, but not a full order of magnitude worse.

There is a wide consensus in the world of economics and political economy, which has merit to it, that the central flaw of communism was too strongly divorcing the benefits of production from the process of producing economic things of value, and thus destroying the incentive for participants in the system to be maximally productive. The incentives present in the Communist system to be productive (and to do so in a high quality way) weren't strong enough.

As an aside, there was also a strong secondary flaw of Communism, which was that it employed centralized economic decision-making to a degree greater than was technological feasible.

The manifest failure that arose from divorcing the rewards for engaging in wealth creating activity from the benefits that arise from that activity is the primary reason that policymakers and politicians are loathe to establish a maximum income or to establish extreme high taxes on very high incomes, on gifts and inheritances, or on property ownership, akin to those in place during World War II and in the immediate decade or two afterwards, even though, in that context, these very high taxes on the very rich did not appear to undermine the incentive of the people subject to them to continue to be economically productive. 

Indeed, as I'll explore in a bit, there is even a plausible argument that these high but not 100% taxes actually created an incentive for the ultra-rich to be more productive, rather than causing them to work less productively for lack of an incentive to do so.

The first order problem which has material impact on the overall economy is that economic rewards have diminishing marginal returns. When you have a net worth of tens of millions of dollars or more that you acquired from a habit of intense full time work that was highly productive, and from good investment decisions that are a result of time consuming research, you are often hard pressed to find ways to consume your economic wealth faster than it is growing, even if you try hard in a way comfortable with your lifestyle, to do so. I see this routinely in my daily life as an attorney for people in this situation.

The United States has thousands of people who are first generation rich with net worths in the hundreds of millions of dollars or more, for whom the diminishing marginal returns of additional economic wealth achieved from working productively have vanished to almost nothing. The ability of these people to consume for the person benefit of themselves and their families is barely influenced at all by whether they work, or within very broad tolerances, the decisions that they make on the job if they do work.

At this level of wealth, making value and wealth enhancing decisions gives their companies more economic power which they get to wield, but when it  comes to the well being of and consumption for themselves and their families, they may as well be playing with monopoly money. Indeed, personal accounts of the lives of the ultra-rich suggest that it isn't even clear if the actual personal use of the marginal increases in wealth that these big shots make when they are active in their businesses is a meaningful incentives that drives them to be more, rather than less, economically productive at all.

These are troublingly thin incentives for people who directly own well over a quarter of the wealth in the entire economy (they earn about a quarter of the nation's income, but wealth is distributed more unequally than income), and control something closer to three-quarters or more of the nation's economic capacity. And, honestly, the incentives for other powerful people in our political economy to make the objectively best decision, like members of Congress, judges, and other elected officials, is also thinner than one might hope to have in an ideal world.

Nonetheless, first generation fortune makers tend to be so habituated to hard, highly productive work, that they tend to carry on doing so long after the marginal consumption benefits of doing so have dwindled to essentially nil. They are working because they enjoy the thrill of the challenges that they face while doing so, and to chase power and fame and their personal dreams for their enterprises themselves.

But there is also a huge swath of people in the U.S. who have vast wealth that they didn't create, mostly because they inherited it, or are otherwise parts of families in which someone else in the family created this wealth. 

One of the most famous economic papers on the subject called them the "leisure class." These people often have the formal power to determine how this wealth is invested, despite having no qualification other than the accident of birth, to make those decisions. Also, even when, as is often the case, they are talented people with the potential to engage in very productive work, these people often end up living self-indulgent lives in economically unproductive pursuits because they can and they have no economic incentive to do otherwise. And, the members of this small but not economically or numerically negligible leisure class are hoarding economic resources for no purpose other than their own amusement that make up a quite significant share of the nation's total economic wealth, despite the fact that there are other people living in severe economic hardship, and despite the fact that there are a great many potential public and private investments that do not get made because the resources are tied up in assets that amuse the members of the leisure class.

Even ardent supporters of capitalism and the status quo generally agree that the leisure class behaves in a manner that is detrimental to our economy in the big picture and wastes scarce resources. But they see it as a necessary cost of giving ultra-productive wealth creators a sufficient incentive to make our economy more productive, even though the veracity of this assertion is, at best, vastly oversimplified, and more likely, much more wrong than it is right, even if it has a small nugget or two of truth buried in it. It is not a good description of what is motivating the ultra-rich who control big business and major economic assets to make more money.

In addition to the issues of the incentive of the "self-made" (relatively speaking only) ultra-rich to work, and the economically problematic leisure class, there is also a third related issue.

A significant number of "self-made" (relatively speaking only) upper middle class people, who are extremely talented and capable of highly productive work, rather than continuing to work out of personal virtue and habit, have been rewarded so generously for their early efforts that greatly reduce their productive activity or entirely retire long before they are unable to work. They retire early because they don't need to work any more to consume everything that they wish to consume. If they had been rewarded less generously for their high productivity early on, they would have worked more hours and more productively to achieve an ability to have satisfactory consumption and would have made our collective economy richer. But instead, because they were rewarded so generously at first, their lifetime productivity is reduced.

The incentive issue that made Communism a failure is more pressing in this last case than in the others, but it isn't that black and white. At the margins, our society would produce more, because these individuals would produce more over their lifetimes, if these highly productive upper middle class individuals didn't receive quite such large rewards for their efforts causing them to have to work more to reach a satisfactory amount of wealth. And, this issue is still significant enough to have material macroeconomic impacts on the size of our economy.

My goal today isn't to identify solutions to any of these issues. That is for another day and other posts. But these flaws in our status quo economy are real, are material, and are severe, to an extent whose materiality is not acknowledged nearly as widely as it should be. 

Some people on the progressive left do indeed say a lot about the problem of the concentration of wealth in our society being problematic. But very few of those who are doing so acknowledge the intrinsic difficulties involved in solving the problem in a way that does more good than harm due to the problems that made Communism a failure. Many of them are convinced that great wealth is dishonest to a far greater extent than is the case empirically. And, many do not recognize that incentives to be economically productive are indeed really, really important, or that there is a serious incentive problem in the world of the ultra-rich, which is extremely important economically to the entire economy.