Thursday, May 13, 2010

My Response to Robert Frank's ...

Reading Robert Frank’s most recent post, I have the impression that he is puzzled and frustrated by my failure to be convinced by his obviously correct arguments for his position. If so, our feelings are similar, since I remain puzzled as to why, after I have pointed out the gaping errors in his argument, he continues to repeat them. Instead of making another attempt at a point by point response, I am going to try to step back, summarize his argument as I understand it, and try to show what is wrong with it. That should give him an opportunity either to understand my argument, if the problem is that he doesn’t, or to point out how I am misunderstanding his.

The basic claim made in his Op-ed and defended in his posts here is that poorer people are worse off due to the existence of richer people, richer people better off due to the existence of poorer people, hence that it is only just to compensate the poorer at the expense of the richer. That claim has two parts. One is his old argument about the effects of the fact that humans care about (among other things) relative status. The other is the claim that, concern with relative status aside, the existence of rich people makes the less rich materially worse off and that the existence of poor people makes the less poor materially better off.

The first claim is, I think, correct; humans do care about relative status. But, as I pointed out in my initial post and as each of us has agreed since, those effects are local, hence provide no justification for income redistribution on a national scale. In his most recent post I think Robert Frank to some degree concedes that, referring to his own argument as “difficult-to-document claims of psychological damage used [caused?] by inequality,” and recasts the argument in terms of “concrete costs” due to a cascade of competitive expenditures, in effect substituting for his first claim a version of the second. Doing so makes the first half of the argument in his Op-ed, his old analysis of the effect of concern with status on wage differentials in the market, almost entirely irrelevant to the second half, his defense of governmental income transfers. Yet it was the first half which was supposed to persuade libertarians that they should approve of the transfers defended in the second, since they only reflected, on a larger scale, what would come out of voluntary interactions in a world without transaction costs.

It is the second claim that seems to me strikingly mistaken. He has now twice—in his most recent post and the one that preceded it—first agreed that what matters in health care is the absolute level and then proceeded to put his argument in terms of the relative level, not how good the health care is that someone can get but whether or not he can get “the best” health care.

Perhaps my point can be made clearer if I put it in terms of a comparison between two hypothetical societies which differ only in the number of wealthy inhabitants; the second consists of the first plus an additional million people, each with an income of a million dollars a year. Obviously, if they get that income by stealing it from everyone else, their presence makes other people worse off, but that is not Robert Frank’s argument. He started, after all, with an explanation of why the wages of more productive workers do not fully reflect their additional productivity. Hence I think I can fairly assume that each of those million gets his income by producing goods and services worth, to other members of the society, at least a million. The question is then whether people other than the million wealthy are worse off in the second society than in the first.

One of the things the additional people will spend their income on is medical services. Hence the second society will have more, and probably better, medical services than the second—more good hospitals, more highly trained surgeons, a larger quantity and probably a larger variety of medical drugs. We might quantify the effect by supposing that the first society has a million doctors whose skill ranges, on some metric, from one to ten, and the second adds to that an additional ten thousand whose skill ranges on the same metric from five to eleven—all of whom are providing their services exclusively to the additional wealthy people.

Robert Frank tells us, correctly, that “When a serious health problem strikes, a person wants the highest absolute quality of care possible, but because the quality and quantity of care are limited at any given moment, not everyone seriously ill patient can have the best. My claim, which is surely completely uncontroversial, is that someone with high social rank is more likely than others to get the best care.” That sounds as though it means that the addition of people of high social rank reduces the quality of medical care available to those of lower rank—but it doesn’t. In my example, constructed to simplify the argument but consistent with his view of the situation, it means that someone who before got medical care of quality ten is still getting medical care of quality ten. The reason he is no longer getting “the best care” is that there are now other people getting care of quality eleven.

Robert Frank conceded, two posts back, that what matters is the absolute level of medical care not the relative level. To complain that someone is no longer getting the best level with the implication that he is now worse off, when what has actually changed is not the medical care he can get but the care others can get, is to treat a relative change as if it were an absolute change. It is his failure to see that very simple point—now twice repeated—that makes me feel as frustrated at his responses as he appears to be at mine.

There is, I think, a second error embedded in what I just quoted, this time in the words “at any given moment.” If my additional million people, complete with their income and their demands for medical care, suddenly appeared in a society, and if none of them happened to be physicians, they would indeed bid existing medical services away from others.

But that is not what is happening, either in my hypothetical or in the real world that we have been arguing about. Putting the analysis in terms of “any given moment” implicitly converts the real economy, in which goods are produced as well as consumed, into the fixed pie economy that one can imagine existing at any single instant, with production frozen and consumers competing over already produced goods. That is a perspective popular with people making political arguments, especially ones in favor of income transfers, but a very odd one for an economist to adopt.

I have focused on medical care, but the same analysis applies to education. It is true that having gone to a better school makes you likely to be accepted into a better job. But the distribution of available jobs is not frozen any more than the distribution of available medical services; both reflect, among other things, the distribution of productive abilities in the society. If my additional million people spend part of their income on their children’s education the result will be more well educated people, hence more very productive people, hence more high paying jobs. The individual who before would have gotten the best job the firm offers at a salary of a hundred thousand a year now gets only the second best job the firm offers—at a salary of a hundred thousand a year. It is true that “persons of high social rank are more likely than others to be able to send their children to the best schools.” But the best schools are now better, as are the jobs available to the graduates of the best schools, so the graduate of what is now only the second best school need not be, in any material sense, worse off. Again there is a confusion, although a less obvious one, between relative and absolute.

In arguing that the poor are not made materially worse off by the existence of the rich I have understated my case. In material terms, Robert Frank’s account is not merely wrong, it is backwards. Not only do poor people not lose, materially speaking, from the existence of rich people, they can be expected, on average, to gain.

This is true for two reasons. One I already pointed out in my previous post. The production cost for some things—medical drugs are a particularly striking example—is in large part the cost of generating information. The more buyers that is divided among, the less the cost to each. The fact that some people are wealthy results in a larger demand for medical drugs, which makes any particular drug less expensive, as well as funding the development of additional drugs. That is a benefit to the poor as well as to the rich.

The second reason is a point underlying the principle of comparative advantage: we can gain more by exchange with people who are different from us than with people who are similar to us. I would have a hard time persuading any of my colleagues to mow my lawn at a price I would be willing to pay. The recent immigrants who in fact mow my lawn would have a hard time persuading any of their friends and relations to pay them a price for mowing a lawn that they would be willing to accept. I am better off by the existence of the immigrants and they by my existence—our different situations make possible exchanges to our mutual advantage. Generalize that and it follows that the rich are indeed made better off, as Robert Frank believes, by the existence of the poor—at least in the context of voluntary interaction on the market—but the poor are also better off by the existence of the rich.

Robert writes: “Unless David has new evidence that persons of low social rank have greater access to the best health care and greater access to the best educational opportunities, I hope he will abandon these objections.

Unless Robert has evidence that persons of low social rank have access to a worse quality of health care and education than they would if people of high social rank did not exist or had lower incomes than they do, I hope he will abandon arguments that hinge on the word “best,” and so depend on confusing relative with absolute outcomes.

17 Comments:

At 3:41 PM, May 13, 2010, Blogger Michael F. Martin said...

Now we're getting somewhere...

But that is not what is happening, either in my hypothetical or in the real world that we have been arguing about. Putting the analysis in terms of “any given moment” implicitly converts the real economy, in which goods are produced as well as consumed, into the fixed pie economy that one can imagine existing at any single instant, with production frozen and consumers competing over already produced goods. That is a perspective popular with people making political arguments, especially ones in favor of income transfers, but a very odd one for an economist to adopt.

What is the appropriate temporal horizon over which to decide whether a given allocation of resources is welfare maximizing? Suppose we agree that an exogenous reallocation from rich to poor is not optimal. We might nonetheless remain agnostic as to whether a reallocation that would take place due to endogenous effects over a very extended period of time would be profitably accelerated through exogenous reallocations -- e.g., by H.R. policies or government regulations.

The information problem with deciding the appropriate scope -- both temporal and social -- is serious. But there do seem to be a handful of situations in which the information problems seem less serious. Nationalizing health care insurance in the 21st Century U.S. is not one of those situations, to be sure. But what about mandatory tithes for the support of welfare for widows and orphans in religious communities in the 12 Century in Europe?

Some of this argument seems to come down to the commensurability of different conceptions of welfare. Prof. Friedman's seems very income-oriented, which is sensible in view of the information problems. But surely there must be some difficult-to-measure principles of welfare that we can incorporate into policymaking without fear of transgressing the all-important goal of an optimal allocation of resources.

To tie this into the story about the society + 1 million millionaires -- how much of an incumbent advantage do we want those millionaires to have in maintaining their status? In a society with zero redistributive mechanisms, this elite would be far more stable. The argument that comparative advantages will shift over time, thereby naturally turning over the elite, is not entirely convincing.

 
At 4:12 PM, May 13, 2010, Blogger Michael said...

You two seem to be using macroeconomic theories to describe individuals. The poor are poor because of the nature of their character.

My mom taught in a school district made up of 3 communities. 2 of the communities are very upper middle class and the 3rd is lower middle class.

The parents of the 3rd community have a much higher level of indifference to the education of their children than the other 2 communities.

No amount of government policy is going to change this. The sooner government learns that people have different abilities and aptitudes, desires and goals, and some are just plan lazy, and ends the nonsense of social justice, the better all Americans will be better off.

And for most people, status as only important in high school, which I guess says a lot about the people obsessed with it.

 
At 4:12 PM, May 13, 2010, Anonymous Anonymous said...

"The production cost for some things—medical drugs are a particularly striking example—is in large part the cost of generating information. The more buyers that is divided among, the less the cost to each. The fact that some people are wealthy results in a larger demand for medical drugs, which makes any particular drug less expensive, as well as funding the development of additional drugs. That is a benefit to the poor as well as to the rich."

In other words, increasing total wealth is good, even if it is unequally distributed. However, that doesn't answer the question of whether increasing income inequality, holding total wealth constant, is good or bad.

 
At 4:13 PM, May 13, 2010, Blogger David Friedman said...

Michael writes:

"What is the appropriate temporal horizon over which to decide whether a given allocation of resources is welfare maximizing?"

That might be an interesting question, but I don't think it is what we are arguing about. I haven't been arguing that transfers are (or are not) welfare maximizing. I've been arguing that the particular justification for transfers offered in that Op-ed is wrong--doesn't work in its own terms.

 
At 4:48 PM, May 13, 2010, Blogger Michael F. Martin said...

Thanks for the reply. Reading back over the debate, I think there is some crosstalk on this very point. As I understand him, Frank sees both private (H.R. policies) and public (progressive taxation) as welfare maximizing because transactions costs prohibit the customization of such institutions to individuals' preferences. The point in his NYT OpEd, as I understood it, is that libertarians should either not object to such public institutions because they don't object to such private institutions, or object to such private institutions because they object to such public institutions.

As I understand your replies, you're disagreeing with the premise that the public institutions are comparable to the private -- e.g., that progressive taxation is comparable to H.R. policies. One basis for your disagreement (your original point 1) is that the scale matters. Progressive taxation is not like private H.R. policies because I don't compare myself to people I never see whereas I may compare myself to coworkers.

A comment I have made along the way is that I don't think the question can be resolved on a purely logical basis. The scale of interpersonal comparisons that affect welfare seems to vary from good to good (you both agree, for example, that its slope at least is much lower for health care services).

I would much rather see a discussion of what kinds of data could be used to measure how interpersonal status comparisons affect welfare than a debate over whether such comparisons can ever be used in policymaking.

To be clear, I understand why a libertarian might not want to go down that road as a matter of principle. (Isn't that the heart of the point 3 you started with?) I simply don't agree that the principle is one that can be established a priori. Whether it is in each person's interest to assent to a particular redistribution or not seems to me to be an intensely contextual question.

 
At 9:50 PM, May 13, 2010, Anonymous Anonymous said...

To invoke a common criticism, David's model is too simplistic to be applied to real world circumstances.

 
At 10:59 PM, May 13, 2010, Blogger Michael said...

As someone that has to live though economist's models, none really deal with real world circumstances.

It's all about controlling people.

 
At 1:52 AM, May 14, 2010, Anonymous Michael P said...

I think this topic would make for an excellent discussion on bloggingheads.tv I would love to listen to the two of you talk it over.

 
At 3:32 AM, May 14, 2010, Anonymous Sid said...

Prof. Friedman, in the second paragraph you wrote :

``But, as I pointed out in my initial post and as each of us has agreed since, those effects are local, hence provide no justification for income redistribution on a national scale''.

How does this refute his argument ? He is essentially using an externality argument, not a moral one. The first part of his argument claims that a rich people spreads unhappiness/
low self-esteem in the neighborhood. This is logically somewhat similar to
factories spreading polluted air in the neighboring areas. Now your argument
seems to imply that there is no justification for restriction of
pollution on a national scale since the effects are local.

 
At 10:11 AM, May 14, 2010, Anonymous Art T said...

One minor objection.

David writes: "The production cost for some things—medical drugs are a particularly striking example—is in large part the cost of generating information. The more buyers that is divided among, the less the cost to each."

This is the benefit of having more people, not necessarily more rich people.

 
At 2:40 PM, May 14, 2010, Blogger Vadim Iaralov said...

@Cost of drugs example.

The key empirical question is whether goods poor people care about are in fixed supply, have decreasing returns to scale, constant returns to scale or increasing returns to scale.

Drugs have increasing returns to scale because of research costs. On the other hand, usable urban land is in a more fixed supply (here rising land prices hurt the poor) -- think Manhattan. Likewise for road congestion. Also, rich people can support more mates than 1 (wives+girlfriends or husbands+boyfriends), so it's possible that marriage prospects of median poor person would decline.

On the other hand, greater specialization as David outlines will allow creation of new industries and new technologies, some of which might have public benefits. If rich people invest in private space tourism or cellular phones, some affordable version may come along later.

 
At 2:48 PM, May 14, 2010, Blogger David Friedman said...

Art writes:

"This is the benefit of having more people, not necessarily more rich people."

Richer people spend more money on medical care, hence increase the size of the market for it.

 
At 3:57 PM, May 14, 2010, Anonymous Anonymous said...

Richer people spend more money on medical care, hence increase the size of the market for it.

But do they change the market in ways which will disadvantage poor people?

"Sorry, you used to be able to get cheap and frugal treatments before all the rich people came here. Now the local medical school only teaches gold-plated medical care. And the med school has a natural monopoly, so there's no market for a medical school which will teach cheap care."

 
At 10:53 AM, May 15, 2010, Anonymous Anonymous said...

"Richer people spend more money on medical care, hence increase the size of the market for it."

To echo the other anonymous, this is a perfect example of your model being too simplistic for reality. There is no free market in medical care, so there is no reason to think that the benefits of a free market would be realized.

 
At 7:01 PM, May 15, 2010, OpenID hudebnik said...

If my additional million people, complete with their income and their demands for medical care, suddenly appeared in a society, and if none of them happened to be physicians, they would indeed bid existing medical services away from others.

But that is not what is happening, either in my hypothetical or in the real world that we have been arguing about. Putting the analysis in terms of “any given moment” implicitly converts the real economy, in which goods are produced as well as consumed, into the fixed pie economy that one can imagine existing at any single instant, with production frozen and consumers competing over already produced goods.


Yes, that's a fallacy, but it's an equally serious fallacy to assume that economies have reached equilibrium. If a million millionaires appeared immediately, it would take 10-20 years to expand medical schools and train enough doctors to care for them. And by that time, some other unpredictable external event would kick the health-care field out of equilibrium in another direction. Of course, in the interim, the bidding power of the extra million millionaires would make health care less available to other people.

And will adding a million millionaires produce enough economic activity to create a million jobs that are at least as desirable as the existing jobs? If not, then some of the existing population will lose jobs to them.

 
At 8:47 PM, May 15, 2010, Blogger David Friedman said...

". Of course, in the interim, the bidding power of the extra million millionaires would make health care less available to other people."

The millionaires are each producing a million dollars of something--that's why they are millionaires (income not wealth). No reason why it's less likely to be medical services than what other people produce. We aren't talking about dropping a million people into a society, we are talking about the effect on a society of the fact that certain people are there--in this case, especially productive people.

Robert wants to claim that the fact that rich people are there makes the less rich absolutely poorer, in terms of their command over important kinds of goods and services, such as medical care--and he hasn't offered any reason to think it's true.

 
At 8:29 PM, May 17, 2010, Blogger David said...

I think that Frank is taking "absolute" and "relative" in a different way from you; hence the continued disagreement even though he accepts that people are interested in the absolute level of medical care they get, rather than the relative level. He doesn't take the absolute level to be the care someone receives, without reference to the care anyone else gets. Rather,he asks, what is the top level of care available in society at a time and thinks people are interested in that. He doesn't take this to be an interest in relative position, so long as what motivates people isn't whether other people receive the best level as well. So long as the poor person says, "I want access to the best doctor", not "I want access to a better doctor than you have", I think that Frank would say the poor person is interested in the absolute level of care.
(I tried to post another version of this, but it didn't go through. Sorry if I am now double posting.)

 

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