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Keith Rankin: Perceptions of Inequality

Perceptions of Inequality
Keith Rankin, 31 January 2002

Many people think that economics is (or should be) a glorification of the market. Leaving aside alternative economics, textbook economics is merely a way of describing market capitalism. Thus, for an economist, the market is neither good nor bad. The market simply is.

A couple of weeks ago (17 January), a schoolteacher of economics (Peter Lyons) had an excellent article (Income inequality hinders nation's economic growth) published in the Herald.

On the following Saturday, Lyons was subjected to a gratuitous attack by John Roughan (It's a great time to be a sporting couch potato), a senior Herald journalist who is known for his faith in the virtues of market capitalism.

The attack was particularly worrying because it represented an abuse of power by one who has privileged access to the mainstream media. Sure enough, a mini-bandwagon followed. We have all heard the talkback callers who seek self-esteem by regurgitating the talkback host's previously expressed opinions. Letters to the editor are also often like that. So, following Roughan, two letters were published attacking Lyons' competence as an economics teacher (22 January). In effect Roughan had used his position to give members of the public licence to question not Lyons' interpretations of the economics literature but his competence as a teacher.

My main point here is to show how this sequence of events involves the market faithful propagating market failure in the education industry and the knowledge economy; an irony that Lyons' critics might not be able to appreciate. But, before I do that, I should summarise the central point of Lyons' article and the reason why Roughan's attack simply missed the point.

The article was about the ways income is distributed in a pure market economy. The textbook justification/explanation for inequality, as Lyons noted, is that people vary in their individual productivities. In particular, those people with "human capital" (eg doctors) contribute more to the economic cake than do unskilled workers, and that income inequality simply reflects these differences in contributions.

Now most reasonable people recognise that the basic textbook description is naïve. Certainly the authors of the stage 1 textbooks appreciate that naivety more than most. Hence there are alternative descriptions, some of which imply that the market system is unjust, and that market injustice has measurable impacts on the collective wellbeing of society. One such alternative explanation in the professional literature - central to Lyons' article - is called "winner takes all", a snappy title that more correctly means "winners take most".

Theories like "winner takes all" are not the value judgements of the market unfaithful. Rather they are attempts to explain observed outcomes. Outcomes are judged by economists as "good" or "bad" according to the standard criteria of economic efficiency. "Winner takes all" outcomes are seen by professional economists as inefficient because (i) capable people who have been marginally more productive than their capable peers receive incomes many times greater than their peers (as opposed to marginally more), and (ii) that this process creates false "price signals" which encourage an oversupply of people entering occupations glamorised by a small number of high-profile high-earners. If some occupations are oversupplied, then other occupations must be undersupplied. The resulting misallocation of human resources means that the economic cake is smaller than it need be. That's what is meant be economic inefficiency.

As any good economist should, Lyons explores the implications of the theory he is reviewing. He implies that high earners themselves apply the naïve 'human capital' view to explain their own pre-tax incomes. This inference seems highly plausible. After all, it makes sense for overpaid winners to regard their own incomes as an accurate measure of their personal worth to society. Further they are now in a position to argue, given their higher average rates of income tax, that they are relatively underpaid, after tax.

Tiger Woods and Anna Kournikova were used as topical examples of overpaid winners. Indeed, in New Zealand in 2002, they were both paid more than those who outperformed them. The counterargument is of course, as Roughan suggested, that Woods and Kournikova provided more value to the couch potato consumers of golf and tennis services than did the winners of their respective events.

The proper way to have disagreed with Lyons would have been to suggest an alternative to the "winner takes all" explanation and/or to have argued that winners do actually generate many times more value to society than do the also-rans.

Instead, by making the gratuitous claim that Lyons would be professionally incompetent if he taught the theories featured in his article, Roughan, in assuming that his own faith is superior to Lyon's professional knowledge, simply exposes his own lack of objectivity.

The problem of perceptions remains. Roughan, without any grounds to do so, created adverse public perceptions by questioning Lyons' competence as a teacher. Indeed I suspect that Roughan was quite intentionally attempting to create such a perception.

Therein lies a big problem. Textbook market economics assumes that decisions by buyers and sellers are made on the basis of complete and factual information. Further, that information is assumed to be a free public good.

Market reality is very different. Decisions are made on the basis of subjective perceptions rather than on the basis of objective shared knowledge. Indeed the 2001 Nobel prize was awarded to three economists who worked on the problem of how markets work when one contracting party knows more than the other.

One market that is very sensitive to perceptions, rumours etc. is the education market. Consumers want to know which are the "bad schools" to avoid. So planting a false perception that a particular school is bad is potentially very damaging, not only for the school in question, but also for society as a whole. It is economically inefficient for education consumers to avoid a school that is in fact a good school.

Take that one step further. What board of trustees would hire an economics teacher who may well be very good but is known to be (or is perceived to be) tainted by negative perceptions? The signal from the marketplace is that economics teachers who wish to maximise their likelihood of prosperous employment should avoid taking part in public debate, especially with respect to the issues that they are most qualified to comment on.

In an economically efficient world, teachers contribute to the exchange of ideas. They share their professional knowledge and insights publicly as well as in the classroom. New Zealand suffered severely in the 1980s because only a tiny minority of teachers were willing to compromise their careers by taking part in public debates.

The abuse of power by prominent people with privileged access to the media creates false perceptions. False and distorted perceptions are a direct cause of sub-optimal economic outcomes. The suppression of the public exchange of ideas that is caused by the fear of false perceptions is possibly even more damaging in the long run.

Our society is not free so long as the word "courageous" is applicable to teachers who contribute to public dialogue. Economics teachers are observers of markets, not cheerleaders for markets. Those who judge economics' teachers poorly for displaying a healthy dose of professional scepticism are themselves condemned.

© 2002 Keith Rankin

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