Adam Smith, income inequality and the rich

Perhaps under the influence of Amartya Sen who has written extensively about Adam Smith (and including here: an article I like a lot), I had the impression that the contrast between “The Theory of Moral Sentiments” (TMS) and “The Wealth of Nations” (WoN) was the one between a “softer”, more philosophical,  version of Smith and a “harsher”, more economistic  one.

But after recently reading TMS (of which earlier I might have read just a few pages), I think differently. I read TMS with an eye towards Smith’s treatment of income inequality, the rich and the poor. And my impression of Smith’s treatment of the rich in TMS is that of a clergyman of his time:  slight, and at times even strong, contempt for the rich and their moral failings, but an equally strong acceptance of the immutable order of the world. To the rich, this world; for the next, we shall see. To the poor, the message of meekness and acceptance. Their moral fortitude is never questioned, while that of the rich is. But there is no attempt to change the position of the poor here below, nor any attempt to expose the origin of the wealth of the ethically-challenged rich.  It is as if, after Russian privatization, we would deride the taste and the spending pattern of the oligarchs, but never question the way they acquired oil fields.

Moreover, in a Smithian fashion that has since become his trademark, the very moral weakness of the rich, their attempts to show off, lead them, as if by “an  invisible hand” to equalize economic outcomes of themselves and the poor. In a remarkable passage, where the “invisible hand” is mentioned for the first out of two times ever, Smith writes:

They  [the big proprietors] are led by an invisible hand [through their spending] to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species. When Providence divided the earth among a few lordly masters, it neither forgot nor abandoned  those who seemed to have been left out  in partition. “ (TMS, part IV.I.10). 

The story is a bit thick: unequal ownership of land does not really matter because the rich have to spend their income one way or another, they have to hire cooks, gardeners, farmers to raise cattle etc.  and are thus as if by “an invisible hand” led to an outcome that in terms of distribution of consumption looks similar to what it would have been if the land were divided in equal parcels.  Obviously, Smith must have known that this is a joke: me, ordering waiters around and eating best food, is not the same as me, being a waiter, producing that food and  serving it.

Overall, Smith’s tone towards the rich and the poor in TMS is both patronizing and fatalistic. The rich may be despised, but the order of the world must not be disturbed.

But  the tone in “The Wealth of Nations” is very different. Here, not only are the rich taken to task for their vanity, conceit, and concern with “trinkets, baubles and trifles”, as they were in “The Theory of Moral Sentiments”, but in a much more hard-hitting way, the origins of their fortunes are exposed and often found in spoliation, monopoly and “conspiracy against the public”, as in the famous passage:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.  It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary. (WoN, Book I, Chapter X)

Just think of Davos, Bilderberg and the Trilateral Commission. 

Similarly, the rich civil servants never forget to overpay themselves,

The emoluments of offices are not…regulated by the free competition of the market, and do not, therefore always bear a just proportion to what the nature of the employment requires. They are, perhaps in most countries, higher than it requires; the persons who have the administration of government being generally disposed to reward both themselves and their immediate  dependents rather more than enough. (WoN, Book V, Chapter 2)

Now think of many governments across the world, from Azerbaijan to Zimbabwe, and international organizations from the World Bank to World Trade Organization.

And what is government?

Civil government…is in reality instituted for the defense of the rich against the poor, or of those who have some property against those who have none at all. (WoN, Book V, Chapter 1)

The last statement, although made in the context of Smith’s discussion of pastoral societies where the first differences in incomes,  according to him, appeared, does clearly apply  to all property-owning societies. The statement is so similar to Marx and Engels’ one from the “Communist Manifesto” (government as “a committee for managing the common affairs of the bourgeoisie”) to be  practically undistinguishable.

Why was Smith much tougher on income inequality and the rich in the “Wealth of Nations” than in the “Theory of  Moral Sentiments”? I think that there are two possibilities. The subject matters of the two books are different. TMS deals with ethical matters and the rich can be, in that context, rightly criticized only for their moral turpitude. In the “Wealth of Nations”, we deal with economics, and the attention is naturally directed towards more mundane matters: how were fortunes acquired and how are they preserved.

A different possibility is that there was an evolution in Smith’s own thinking. While earlier he took social stratification as given, perhaps “God-ordained”, once he started analyzing more carefully where it really came from,  he became much more critical.

I am not a Smith specialist, nor do I know Smith biography well enough, to be able to tell which of the two hypotheses  is more likely. But I do think that there is a clear difference in his attitude toward income and wealth inequality and especially the rich in the two books, and the difference is, in my opinion, exactly the reverse from the one that I understood from Sen.

Three inequality tales

Being at talks and panel discussions at Columbia (yesterday) and Harvard JFK School today stimulated me to make three following observations, all on income inequality. I couch it into three inequality tales.  

           Inequality spillovers

            I  presented this paper yesterday, but will not discuss it now (for a summary of the paper, see here). In the discussion after the presentation I went back to something that impressed me in Stiglitz’s paper on which I wrote a blog several months ago. Suppose that income inequality increases in only one county in the world, which is sufficiently big. Let’s call it China. Then suppose that people from China simply in order to diversify their portfolios, or because they like New York, or because they are worried about political developments at home, decide to start buying real estate in the United States. The owners of the plush properties in the United States, for which the demand goes up, are rich Americans. Then suddenly since their assets go up in price, wealth inequality in the US increases, and if returns to wealth are more or less fixed, income inequality increases as well. There is thus what I call an “inequality spillover”. Unlike in the pre-globalization era when, at least in principle, you could have had inequalities in different countries  “kept” in separate compartments, this may no longer be possible during globalization.

            Could this be one of the forces behind the noted convergence of countries’ inequality levels (see the graph below, indicating that countries with higher inequality before 1980 had smaller increases or even declines in inequality since)? I doubt it. The "spillover" forces are not strong enough. They are still marginal. But in some countries they can indeed exert a more important influence. Portugal has recently liberalized its residence rules in an effort to attract rich non-EU citizens. The unintended result may be an increase in wealth and income inequality domestically. 

            Inequality of opportunity

            In a very nice presentation at JFK School of Government at Harvard today, Chico Ferreira showed the graph below (coming from this paper), plotting the estimated inequality of opportunity (from household surveys) against the correlation between parents’ and children’s incomes. Now, both measures have something to do with unequal opportunities, but they are very different and are calculated from entirely different data sources—so the fact that they move together is important. The inequality of opportunity measure (on the vertical axis)  is the share of all income inequality accounted for by the differences in “exogenous circumstances”, that is race, sex, parental background etc. This is the “bad” inequality, inequality which in principle should be zero. The variable on the horizontal axis is the correlation of income between  parents and  children. The higher the correlation, the less we have equality of opportunity. Ideally, we would expect that the distribution of children’s income be the same for all levels of parental incomes and that the correlation be zero. 

 

            The implication is that the work which tries to decompose inequality into  “good” and “bad” inequality (which I think is one of the major new developments in inequality economics) is showing very promising results. First, two papers by Gustavo Marrero and Juan Gabriel Rodriguez, here and here, showed that “bad” inequality is negatively correlated with economic growth in Europe and the US (and conversely, that “good” inequality is positively correlated with growth). Second, high correlation between this measure of “bad” inequality and inter-generational income correlation shows that we are really up to something: we are measuring something that does make sense and is proxying inequality of opportunity.

            The janissaries

             Chico Ferreira ended his talk by pointing out that if you followed Roemer and Rawls and wanted to equalize opportunities, it is not sufficient that the kids from both privileged and poor backgrounds go to the same schools. What is necessary is to have the very opposite of what we have today: to have kids from poor backgrounds attend better schools. And then he highlighted the importance of parental background by saying that hypothetically equalization of chances would be furthered if Harvard students in the audience would marry students from less privileged and poorer backgrounds, attending less fancy schools. But of course, Chico said, that would imply violation of human rights. So, some measures to reduce inequality of opportunity simply cannot be implemented.

           That last comment made me think of radical historical attempts to equalize opportunities. I thought of at least three. Plato’s idea that children should  be taken away from the parents, and be raised and educated by the state. It would certainly reduce inequality of opportunity and would break correlation between parental and children’s incomes too. It was implemented, partly, in Sparta wherefrom Plato took it for his "Republic" and "Laws". 

            The second radical policy was Ottoman policy of abduction of Christian male children (devşirme in Turkish), conducted in some parts of the Empire. The boys were then trained in the capital to become either an elite military corps (the janissaries, meaning literally “the new army”) or imperial administrators. It provided an extreme form of upward mobility for many of them; some became the viziers (prime ministers of the empire) most notably, Sokollu Mehmed Pasha (in Serbo-Croatian-Bosnian Mehmet Pasa Sokolovic), a kid abducted from his parents in Bosnia around 1510. Mehmed Pasha served for 15 years as Prime Minister under Suleiman the Magnificent and two other sultans. The policy nicely illustrates the trade-off:  yes, you can equalize chances of the kids (for what opportunities to rule would a Christian kid born in a small Bosnian hamlet ever have in life?), but you have to run roughshod over human and parental rights. You make parents possibly forever unhappy, and destroy the entire cultural milieu of a community. But  you do achieve upward mobility.

            The third example is from Communism. There too, there were strong “affirmative action” policies that favored children from workers’ and peasants’ backgrounds. The idea was precisely to compensate such families for unfair treatment they had under bourgeois or semi-feudal governments. I think that it generally worked. If you look simply at Soviet leaders from the late 1950s to Gorbachev, and then more recently to most post-Soviet leaders, they all came from modest backgrounds. This was precisely the result of affirmative action policies. It was no longer the children from affluent or intellectual backgrounds who, like in the early stage of the revolution, were in power. And obviously, aristocracy was gone.

            The same is true in China today. However, these families have now created a new class structure where their own children remain on top. It is notable that both the current Chinese president Xi Jinping and the man who could have become president, Bo Xilai are “princelings”, i.e., come from prominent second-generation Communist families. This point suggests how in order to counteract privilege, affirmative action needs to be permanently reset in motion  (the Cultural revolution comes to mind), but the previous stories also show how equalizing opportunities can, in its turn, be unfair and unjust. A theme for philosophers.