The Economics of Income Inequality: Economic Growth and Incentives

August 2010

Moderator: Welcome to Research Insights, an occasional podcast from the Federal Reserve Bank of Atlanta. We're talking today with Steven E. Landsburg, professor of economics at the University of Rochester. He's in town to speak at a conference here at the Bank, and he'll address the power of economic growth and incentives, among other topics. Welcome, Steven; thank you for coming here.

Steven Landsburg: Thank you very much.

Moderator: I'd like to begin with a simple question about your recent work. Two of your most recent books are The Big Questions: Tackling the Problems of Philosophy with Ideas from Mathematics, Economics, and Physics, and before that, you wrote More Sex Is Safer Sex: The Unconventional Wisdom of Economics. Can you tell us just in a few words what your observations are, some of your most interesting observations in your recent books?

Landsburg: The key observation in both books, and in fact in all my books, is that thinking about economics gives us important insights into the way the world works and that at the same time it can be fun, that you can use ideas from economics to think about everything from the problem of overpopulation, to the question of how people find sex partners and what the consequences of that are, to why people respond as they do to celebrity endorsements. All of the aspects of human behavior that we see around us are illuminated by looking at them through the light of economic theory. And again, the world is full of puzzles, and every one of those puzzles is fun to try to solve, as puzzles generally are.

Moderator: Well, you're formally trained as an economist. How does that help you to inform your work, your observations, and our understanding of the ordinary world?

Landsburg: Well, economists, I think, are particularly sensitive to the power of incentives and the importance of getting incentives right. The way in which the choices that one person makes ends up affecting the choices that are available to another person. The disconnect, the possible disconnect, between what's good for the individual and what's good for society. The surprising ways in which people following their own selfish interests sometimes end up making the world a better place for everyone else, and the surprising ways in which they sometimes end up making the world a worse way for everyone else. And trying to sort those out, trying to understand the patterns of when selfish behavior leads to good outcomes, when selfish behavior leads to bad outcomes. Economists are trained to be very sensitive to those things, to keep an eye out for them, and I think that's a large part of what makes economics such a useful discipline.

Moderator: OK, well, going back to your most recent book, can you give us one case of an observation that provided an insight that you wrote about in the book?

Landsburg: Let's look at, for example, the problem of illegal immigration. How should we think about—or legal immigration for that matter—how should we think about the impact on existing Americans of allowing new Americans to cross the border? On the one hand, there is an affect on wages of lower-skilled Americans, which are probably going to drop in the short run; we have estimates of how big those drops are. On the other hand, there are big gains to American consumers who are going to be able to buy goods more cheaply; big gains to everybody who owns capital, everybody who owns stocks, everyone who owns real estate as the value of those things go up.

I talk in the book about how even if you ignore all of those gains—even if you ignore all the gains to consumers—all the gains to capitalists, the gains to the people crossing the border are so enormous that they absolutely dwarf the losses to American workers. Now, it is a question for policymakers to decide how much we should care about the people crossing the border versus how much we should care about our own citizens, but what the economics does is it illuminates the magnitude of the ratio, or of the difference, between the gains on the one side and the losses on the other, which I think are numbers that a policymaker ought to have in mind when he's thinking about these problems.

Moderator: Interesting. Tell us about what some of the main messages are for your talk here.

Landsburg: The main message is that, until just 200 years ago, nearly everybody who ever lived, lived at about the subsistence level, the modern equivalent of $400 to $600 a year. It's only in the last 200 years that wealth has existed in the world in any substantial level. There were always of course kings and dukes and princes who lived a little bit better, or in some cases a lot better, but they were numerically insignificant. If you had been born at any time prior to the last 200 years, the odds are astronomical that you would have lived on the modern equivalent of $400 to $600 a year.

This explosion of wealth that we've seen in the last 200 years, it's the only force that we know of that has ever lifted people above the subsistence level. It's the only force that we know of that has ever lifted substantial numbers of people out of poverty. It's therefore really worth thinking about where that growth comes from and how to nourish it, and I'm going to talk in the talk about how partly it comes from saving and investment, but I'm going to explain why that can't possibly be the entire story. Instead, it comes mostly from innovation, and it comes from innovation from people who are properly incentivized to innovate.

And so I'm going to talk about the patent system and the incentives that that creates, the good incentives to innovate and the bad incentives to hoard monopoly power and charge high prices. I'm going to talk about how we might reform that system in order to preserve the good and get rid of some of the bad. I'm going to talk about how we might devise better incentives for all of the other institutions, or at least some of the other institutions, that affect our lives; better incentives for politicians, better incentives for jurors. I'm going to talk about how we can potentially make those institutions work more efficiently by being open to more creative incentive schemes.

Moderator: Well, with respect to the current situation and the challenges we face, do you have any comments or observations that might apply to our audience?

Landsburg: The current issue that happens to be most on my mind today as a function of the news articles I happen to have been reading this morning is fiscal responsibility. I keep reading these articles where people talk about how in order to be more fiscally responsible, the government has to do some combination of spending less and taxing more. That's based on a false analogy with households where, in a household, to be more fiscally responsible you can either spend less or earn more. The government, when it taxes, that's not a form of earning, that's a form of moving money from one pocket to another, because the government, after all, represents all of us and when they tax they're taking money out of one person's pocket and putting it into another person's pocket. They're not actually producing anything, they're not creating any more income, they're just moving income around, and so the only direction in which the government can become more fiscally responsible is by spending more wisely, or in some cases by spending less. The idea that raising taxes is an example of fiscal responsibility is, I think, bogus. It's misleading and I would like to stamp it out.

Moderator: OK, very interesting. Thanks for your time, Steven. It was really interesting talking to you.

Landsburg: Thank you very much.

Moderator: Again, we've been speaking with Steven E. Landsburg, professor of economics at the University of Rochester. This concludes our Research Insights podcast on the power of economic growth and incentives. Thanks for listening, and please return for more podcasts.