By the late 1920s income inequality had reached the worst it had ever been with the top 1% possessing 19.6% of all income in America. This vast gap between the rich and the poor lead many to the feeling that capitalism had failed. They began to seek alternatives to the traditional laissez faire approach such as socialism or even communism. Many politicians took advantage of this situation promising various radical, and often implausible, income redistribution plans. And while taxing the rich to give to the poor may sound virtuous and certainly creates more equality it also presents another problem in the economy.
Not only is it rude to take pie off someone else's plate but it also leads to inefficiencies in the market known as deadweight loss. Deadweight loss occurs when a free market equilibrium for a good or service is not achieved and it is the equivalent of dropping your pie on the pavement for the racoon to eat.
Imagine John D. Rockefeller has just discovered the largest natural reserve of pie custard filling known to man. He immediately gets to work extracting and refining his custard and building the first multi-billion dollar corporation in America. On the other end, Little Bobby Tarts works as a poor baker and has just taken out a second mortgage on his house. He is struggling to make ends meet and has to feed his children frozen Safeway pies just to survive. When suddenly, a new socialist-esque reform hits the market, large amounts of pie are now being taken from the satiated and given to the hungry. John D. Rockefeller sees his profits plummet, he can no longer afford to sustain his business at his previous rate and must cut back on production (although he is still very rich). Little Bobby Tarts gets a massive bump to his weekly piecheck and no longer needs to bake pies to feed his family. With this pie redistribution plan John is still very wealthy and now so is Bobby. However, John is refining less custard and Bobby is no longer baking pies. The overall amount of pie in America has fallen.
This is the main trade-off of income redistribution, everyone has a more equal slice of pie but the pie itself is smaller. And while the above example is quite extreme and a little absurd, the main idea still holds true. That taxing the rich and giving to the poor creates a lower average for everyone. This is also true of other attempts for income redistribution. Price floors such as the minimum wage can prevent mutually beneficial transaction from occurring, and subsidies and grants can create harmful transactions. All of which lead to the aforementioned deadweight loss and less pie in the economy.Obviously, the example above is grossly oversimplified and the real world is vastly more complicated. There are situations in which taxing the rich does not reduce their production and sometimes taxes can negate a negative externality. We all want the largest pie with the most fair slices but this is not always possible and the optimal balance between the two is still hotly debated. In the end, my oven does not contain an infinite supply of pumpkin pie and we use economics on the basis of this scarcity to find how optimal trade-offs are made.
Sources:
https://www.investopedia.com/articles/investing/110215/brief-history-income-inequality-united-states.asp
Modern Principles of Economics
The one Steven Landsburg book i forgot the name of
I really liked your blog post and its in-depth analysis of the economic situation that fueled the Great Depression. I found it interesting that so many politicians proposed radical ideas of income distribution, even if it wasn't a feasible plan. On top of that, they often rallied a lot of support which seems odd at first since their plan most likely will fail. However, I guess this goes to show how desperate the American public was that they were willing to do anything in order to make a living. This connects to the clip we watched in class about Huey Long whose income redistribution plan was so far-fetched that it absolutely no chance of being feasible. However, he still gathered a lot of support because it was the ideas and thoughts behind the plan that people really craved for. Also, I found this article really interesting since it delves more into Huey Long's plan than we could cover in class: https://www.hueylong.com/programs/share-our-wealth.php
ReplyDeleteThe first thing that your blog reminded me of was freshman year when we learned about Marie Antoinette saying, "Let them eat cake!" In looking at the American Economic Pie today, I found that, unsurprisingly, much of the unequal distributions of wealth still exist, if not in worse conditions. The American economy has more than doubled its size since the Great Depression. However, while the top 1% of the population's income manages to increase almost every year, the lowest 50% of the population finds themselves with little to no wage increase. Nevertheless, presidencies from Obama to Trump have made efforts to address the increasing wealth gap. Though some efforts for predominant than others, the question arises: can this gap ever be mended?
ReplyDeleteSources:
nytimes.com/2016/12/06/business/economy/a-bigger-economic-pie-but-a-smaller-slice-for-half-of-the-us.html
I love the analogy! I did some more research on the Economic Pie, and I found that an interesting alternative to redistribution in macroeconomics called Grow the Pie. Grow the Pie is an expression referring to the assertion that growing the economic pie by accelerating productivity creates greater availability of wealth and more work opportunities. There are many critics of Grow the Pie, including Senate Democrats who have tried to push for a shift from growth to redistribution, using the research of economists Thomas Piketty and Emmanuel Saez as justification that the majority of income growth only goes to the richest 10% of tax filers. However, many critics of redistribution have criticized Piketty and Saez’s approach as it disregarded Social Security income and relied solely on tax returns. Two years ago, CBO found that real median taxed incomes grew by 51% from 1980 to 2014, and other studies have found around the same growth. However, I do feel that Grow the Pie fails to capture that there is an inherent level of wealth present in individuals in society, and that larger overall wealth will go to benefit these individuals and will not be able to mend the economic and class chasm. Which approach do you prefer?
ReplyDeleteSources:
https://itif.org/publications/2018/11/09/it-still-worth-growing-economic-pie