Thursday, 20 October 2016

The trade-off between equality and efficiency reexamined

After having read and reviewed Stiglitz's book earlier this week, and after having written the following paragraph...
"I too have long considered the relationship between equality and efficiency to be non-linear, instead of just a simple trade-off. Too much equality isn’t good since it reduces incentives, but neither is too much inequality. I would say the relationship is of an inverted-U type where moving to both extremes – too much and too little equality is bad for the economy. The trick is to find an optimal point which reduces the level of inequality where it offers more opportunities for everyone, but also just enough for it to continue to drive incentives. More on that in my next blog post."
...I just had to dig deeper into the whole equality-efficiency trade-off. So I picked up a seminal book from a man who specialized in economic trade-offs, none other than - Arthur Okun! Okun is more famous for his "law" stipulating the linear relationship (read: trade-off) between GDP and unemployment, where every 1% increase in the rate of unemployment corresponds to a 2% decline of GDP. But today I will not be examining this supposed relationship from the 60s, but a more contemporary one (proposed in the 1970s), claiming that there is a similar linear relationship between equality and efficiency, all summarized in the following book:

Okun, Arthur (1975) Equality and Efficiency. The Big Tradeoff. Brookings Institution, Washington, DC. (this would now be vol. 12 of the What I've been reading section)

Okun's book, published in 1975, testifies of this relationship where greater economic equality necessarily to some extent implies lower efficiency of the economy. In other words, lowering inequality comes at a cost of lowering efficiency. He develops a very interesting argument in which he acknowledges this trade-off, but also proposes a set of policy interventions that would increase both efficiency and equality – such as policies aimed at attacking inequality of opportunity, like racial and sexual discrimination in the workplace (which were arguably even greater back in the 1970s than today) and barriers of access to capital. So in a way even though he implies a linear relationship between equality and efficiency, where one is necessarily sacrificed in terms of another, he clearly sees that when inequality is too high, it can also act as an impediment on efficiency. Okun emphasizes on several occasions that he is a stern believer in the market system, but also that some rights (like the right to vote) should not be bought and sold for money. In other words, he believes in the enormous efficiency of the market system (he devotes an entire chapter emphasizing the benefits of the “mixed” economy model vs the socialist economic model), but is also concerned with the moral implications of why some of our basic human rights cannot have a price tag attached to them. The reason why is very eloquently summarized in following sentences: “Everyone but an economist knows without asking why money shouldn’t buy some things. But an economist has to ask that question”. Hence the first chapter.

It is in this book that he also uses his famous “leaky bucket” metaphor to emphasize the inequality-efficiency trade-off. Here’s a brief explanation: say you want to tax the richest families for a certain amount of money (e.g. $4000 per family) and then redistribute this money to the poor so that each poor family gets $1000 (the ratio of poor to rich is assumed to be 4:1). Now imagine you are carrying all this money you took from the rich in a leaky bucket, so that each poor family will necessarily receive less than a $1000. What’s the cutoff value of money the poor would receive for you to consider the transfer efficient? There is basically no wrong answer here – it depends on your preferences for redistribution. Some people would accept 10 or 20%, some 60% (like the author), some almost 99%. The point that the leaky bucket experiment is trying to make is that each redistributive action will necessarily come at some cost in efficiency. But we as a society must accept this in order to lower economic deprivation that not only hurts the economy, but it can also infringe on our principles of democracy.

Okun devotes a considerable amount of attention to the problem of too much power in the hands of certain interest groups and how they might use it to bias the budget (and much more) in their direction. He cites oil producers, farmers, teachers, union workers, gun lobbies, you name it. Specifying the intensity of their preferences through money is a perfectly legitimate manifestation of their democratic right to fight for their interests. However by doing so they necessarily channel public resources to the hands of the few, at the expense of an unorganized majority which lacks enough interest to engage (just as Mancur Olson taught us).

What fascinates me is that this discussion seems so contemporary, yet Okun wrote it back in 1975! Furthermore, he lays out other facts about 1975, where he complains about the “unacceptably” high levels of wealth and income inequality: “The richest 1 percent of American families have about one-third of the wealth, while they receive about 6 percent of after-tax income.” Today that figure is much higher – it is about 18% of total income. In the books on inequality I’ve read so far, the 1970s were the golden age! But according to Okun, it was still too high. Even in the decade when top income tax rates were 75%, America still had the inequality problem.

This can only confirm Okun’s hypothesis that the US has always sacrificed equality for efficiency. Inequality in the US has been and probably always will be higher than in Europe – but that is precisely because of the innovation-driven, trial-and-error, cut-throat capitalism of the US versus the welfare-state, cuddly capitalism of Europe. And that's fine. But the fact is that inequality in neither of these has to be this high. Hence the final chapter where he proposes a set of standard policy measures (some of them quite good, focusing equality of opportunity) designed to combat the “alarmingly” high inequality of the 1970s (sic!), without sacrificing efficiency. 

Building up on Okun: The trade-off reexamined

Following in that direction, I consider the given relationship to be an inverted U-shaped curve, with higher levels of inequality corresponding to lower levels of efficiency (and hence GDP/income per capita growth), and vice versa - too much equality implies a lack of incentives for the people to create wealth. In other words there will (and should) always be some acceptable level of inequality, which in itself is not necessarily bad given that it is combined with high social mobility. However if the levels of inequality are too high they will negatively impact economic growth. The goal is then to find a balance of lower inequality combined with high social mobility, in order to maximize economic efficiency, i.e. to maximize the productive capabilities of the economy. In other words, there is no linear trade-off between equality and efficiency - there is a need to strike a balance between them. I summarize it in the graph below:

We start from the bottom-left corner with the Gini index at its theoretical 0 level, implying perfect equality (each person having the same income). Clearly for that level of equality efficiency (measured as either total factor productivity (TFP) or GDP p/c growth) is also around 0, since no one has any incentives to produce and to innovate given that all rewards are equal. Even at slightly lower levels of equality (after introducing some inequality), efficiency does not increase, assuming that it takes time for agents to pick up the signal that there is now a possibility to work more in order to get more. Then as inequality stats to increase, the level of economic efficiency increases even more as the relationship becomes reinforcing - more people see that their innovation, talent or extra effort will be significantly rewarded so they expand their activities which creates upward pressure on both inequality and efficiency. Until it reaches a point of maximum economic efficiency for a given level of inequality. As I've pointed out in the graph this is not necessarily at the Gini=0.3, it could be either higher or lower than that - this needs to be verified empirically. After that global maximum of the curve, the relationship turns negative - more inequality beyond the efficiency-maximizing level slowly but steadily decreases economic efficiency until society descends into close to perfect inequality (a Gini=1 means one person has all the income), where again there are no incentives to produce, innovate or create new value, given that all of this new wealth will just fall into the hands of the selected few (like in a stationary bandit dictatorship).

The question to ask is why does this relationship between efficiency and inequality suddenly turn from positive to negative? Which are the forces at work that turn inequality not only into a social, but also an economic problem for society, in a sense that greater wealth accumulation into the hands of fewer and fewer individuals undermines productivity and the desire to innovate? The answer is exactly that - as more and more people start realizing that the value they produce is, within a crony system, ending up in the hands of the few, rather than being distributed among the many, their productivity will necessarily decline. It is exactly like living in a communist dictatorship. Most people rationally choose not to innovate because they realize that any wealth they create will be extracted by the state. So a communist dictatorship will always, ironically, resemble a society with high levels of inequality, given that the elite around the dictator will hold not only full political power, but also a vast majority of economic power (if you want examples just take a look at this list to see which kinds of countries score highest in their Gini levels). 

Now, I've deliberately put the US on the right side of the curve suggesting that it is currently beyond the peak of an efficient level of inequality, and that it certainly does have room to lower its current high inequality which would not hurt its economic efficiency. On the contrary - it would most likely improve it. Remember that the total factor productivity in the US has been in a stage of relative stagnation since the 1970s, which I think can be explained by the simultaneous origination of the Third Industrial Revolution and the technological progress that has lowered productivity and kept low and middle-class wages relatively stagnant. Combined with globalization and a host of other factors (read about all of them here) all of them have affected the rise of inequality combined with a decrease of efficiency. An experienced researcher is likely to conclude that perhaps there is an omitted variable bias in this story, meaning that there is one common factor that is affecting both the rise in inequality and the decline of efficiency - technological growth is the perfect example. I agree, the relationship is far from proven to be a causal one. Nevertheless, some levels of income inequality are obviously bad for growth. If the majority of the population is experiencing declining living standards this affects their purchasing power and their consumer choices, which on the other hand puts a lot of businesses in danger of having declining sales. A consumerist society is only efficient if the people can get a decent salary for a decent job. The prosperous cycle is an amazing thing, but it needs to be in motion. If it stops or it slows down (and we can actually measure this by an indicator called the velocity of money, which is dancing at historical lows right now!) then the economy is likely to undergo a period of prolonged stagnation. 

Finally, given that my graph above is a mere theoretical construct, one should really consult the actual data to see whether or not it holds. I intend to do just that in the next few years.

Monday, 17 October 2016

What I've been reading (vol. 11): Atkinson & Stiglitz

Atkinson, Anthony (2015) Inequality. What Can Be Done? Harvard University Press
Atkinson, Anthony (2008) The Changing Distribution of Earnings in OECD Countries. Oxford University Press

The first two books, both written by the same author, Oxford economics professor Sir Tony Atkinson, will be reviewed jointly. The reason is that the earlier book, The Changing Distribution of Earnings in OECD Countries is more a case study summary of the empirical facts behind the rise of inequality in the West in the past century, the point of which is again summarized in the first few chapters of the author’s latest book Inequality. Basically the earlier book is a very detailed portrayal of the worrying inequality trend in the case of 20 OECD economies. It has two main parts – the first which depicts both the theoretical arguments and the summary of the historical trends for all the given countries, and the second which (on over 200 pages) details all the data, the graphs and the individual explanations of the causes of inequality for each of the 20 observed countries. The second book is a popular version of the same argument intended for “the masses”, but in particular aimed at the policymakers. After setting the diagnosis, describing the historical trends, and the economics behind inequality, the author dives into a very ambitious task of setting out a series of 15 concrete policy proposals that countries (but mostly the UK) can apply in order to reduce income and wealth inequality. The final part of the book then discusses the potential objections – are the proposals shrinking the pie, can they be done, will globalization hinder their effect, and finally will they be sustainable within the budgetary restrictions? 

Let’s start with the general conclusions of the first book in order to ease into the policy proposals of the second book. The first book is not intended for the average layman; it’s more an empirical economist’s companion on the vast data on inequality. The true gems of the book for the average researcher are precisely the 200 pages of data and graphs on inequality for each of the 20 countries. It’s a wonderful dataset above all (accessible here), and Atkinson goes to great lengths to describe all the faults and the benefits of the dataset, emphasizing on several occasions how the data is not comparable across countries (and to some extent it is even difficult to compare it within countries given the different methodologies for income reporting).

But before descending into the data he summarizes the trends. And they are in most cases bad. It is the story most people worried about inequality are by now quite familiar with. It has followed a trajectory of a decline after WWII which continued during the 50s, 60s and the 70s, but since the 80s it began to rise reaching its current unprecedented levels – well, at least that’s how the story goes for the US and the UK, Portugal, and the three transitional economies he has in the sample – Hungary, Czech Republic, and Poland, whereas the rest of Western Europe did not see such a high divergence between top and bottom income levels (the main comparison are the income levels of the top 10% vs the bottom 10% of income earners). After presenting these trends Atkinson delivers his own critique of the economic textbook model of inequality, in that technology and varying skills (attained through education) are not enough of an explanation. He adds to them an important role of the capital market (think of interest rates on student loans) but also explains in a bit more detail the so-called superstar model (people with extremely scarce skill for which there is a huge demand) and pay norms. 

In his more recent book, Inequality: What Can Be Done?, he does go a bit deeper into examining some of the causes of the rise in inequality. And he does it by first examining the factors that have lowered inequality in the post-WWII period, only to see most of them reversed in the 1980s making inequality rise again. One of biggest reasons in the post-war decline of inequality was the rise in the share of wages in total national income (reaching 80% of national income in the 1970s in the US and UK). In the subsequent decades the share of capital in income increased whereas the share of wages decreased. Furthermore the welfare state expanded significantly in the post-war era, as did redistributive social transfers. Unemployment was much lower, wage dispersion was reduced as the consequence of collective bargaining and government intervention in the labour market, while the concentration of capital income among the top income earners was in decline. Let’s also not forget the much higher income taxes on top incomes from that period. All of this basically went into reverse since the 1980s (on average higher unemployment, fall in share of wages and rise in share of capital in total income, declining power of unions, a cut in top income taxes and a scaling back of the welfare state). To this I would still add the forces of globalization (unskilled workers are mostly losers from trade) and technological change, as well as the effect of the capital market, changing pay norms and superstars (increasing demand for global talent). 

Although Atkinson here provides a very good overview of the facts, he gets carried away from time to time. For example, I didn’t buy into the argument that high income taxes in the period from 1950 to 1979 (when they averaged 75%!) were necessarily the reason why economic growth was high in the 50s and the 60s. The main reason as to why growth was high in those decades was probably the post-war reconstruction (the broken window hypothesis), plus the post-war baby boom which certainly encouraged greater consumption and hence significantly increased economic growth. When these two forces halted relative stagnation ensured in the 1970s. High taxes had absolutely nothing to do with growth at the time; if anything they could have contributed to the 1970s stagnation, since their relative decline in the 1980s did bring back growth. However, none of this has been empirically verified by anyone to my knowledge.

Let’s move to the proposals. They are exactly what one would imagine in a book like this – popular, to some extent utopist, very bold, to some extent controversial (the author even acknowledges this several times, but stresses that such bold proposals are necessary to make the public discourse move in the “right” direction). What disappoints me is that there is a lack of convincing evidence of the full effect some of these proposals will entail. There seems to be a focus only on one aspect of the story – reversing the factors that caused inequality to rise, without considering how this would affect other aspects of modern societies. Plus some of the ideas seem to me more like back of the envelope calculations than seriously thought-through proposals. Don’t get me wrong, I am in favor of reducing inequality, but a set of “concrete” proposals has to be more precise in how exactly would it affect inequality, and how exactly would it affect economic growth. There are three chapters in the back that are supposed to answer part of this (e.g. there is a simplified analysis of how some proposals would fit into the budget), but its not convincing. Other proposals don’t even qualify given that they are too vague. I understand this is a popular version and that the author clearly decided to avoid too much numbers and complexities not to bore the average reader. But to me, in order to even consider many of the proposals, I require much more details, first and foremost to give an answer how exactly the author thinks many of the proposals could be done (assuming even that they pass through the bi-partisan parliamentary process). Again, I fully understand his reluctance to go into greater detail, plus I understand he wanted to stir the dialogue, rather than to come up with a White Book of ready-made reforms. 

Having said all that, some of the proposals are actually quite good and even easy to implement. Like the capital endowment fund for children (minimum inheritance), the national savings bond to encourage savings, the child benefit to be extended to all children (and taxed as income for parents with higher incomes), the participation income proposal (similar to basic income, but different in terms of who has the right to get it, and how much), the earned income discount proposal, an interesting proposal for progressive lifetime capital recipient tax etc. However other proposals go directly against the empirical evidence the author himself cites. He does it on purpose (to create an effect of shock). E.g. he cites the paper by Brewer, Saez, and Shephard where they use a natural experiment setting to calculate the optimal top income tax rate (the one that would maximize revenue) at 40%. Atkinson however purposely calls for a top rate of 65%. Then there is the guaranteed public employment proposal (without at all calculating its effects), the code of practice for determining the living wage (to be determined by something closely resembling a central planning body), the proposal for property tax which disregards its potential effect on housing prices, etc. Overall, the proposals are certainly very interesting, however I would welcome a more detailed and more empirically justifiable argumentation for each of them.

Stiglitz, Joseph (2012) The Price of Inequality. WW Norton 

In what is essentially perceived to be a book about inequality, the Nobel-prize winner Joseph Stiglitz presents a very interesting portrayal of everything that went wrong in the US in the past few decades, in economic but also in political terms. Despite stable GDP growth, even in per capita terms, most citizens have not felt this growth and have actually witnessed their living standards decline. The US political system is failing as well; it is being captured by special interests which channel money towards the wealthy (via direct involvement in government redistribution but mostly via prone regulation and legislation), making America less and less a country of equal opportunity. In fact, the decline of social mobility, emphasized several times in the book, is an even bigger problem for the US. Both the poor and the rich are becoming entrenched in their positions in the income distribution, making it increasingly less likely for someone who is poor to climb the income ladder way to the top, and vice versait is very unlikely for someone who is rich to fall out of this category (educational opportunities play a key role here). All of this is without doubt true and very problematic as the US model of democracy is being shaken to its core. How can the US express its moral authority over others if it too has fallen into the trap of cronyism? Stiglitz however does not explicitly define all of the above as the consequence of cronyism or even interest group state capture; he likes to present it as a market failure, but also a political failure to deal with the market failure. 

For Stiglitz there is something broken in system; a system that seems to be designed to help those on the top at the expense of the rest of society. His main culprit here is politics, even if some of these forces are attributed to markets. The economic elites have used their money to buy political influence and hence political power in order to shape the system towards their benefit. This may sound a bit like conspiracy theory, but it has some merit. There are a multitude of examples of political capture by interest groups (via campaign contributions), but even more importantly regulatory capture (when an industry directly funds the politicians responsible for overseeing their practices), or even what Stiglitz defines as ‘cognitive capture’ – how only those who “agree” with the bankers are allow to write legislation and regulation that concerns the financial industry (this includes central bankers as well). 

An even bigger problem is how the wealthy (the top 1%) have acquired their wealth. Stiglitz attributes much of it to – rent seeking. An activity where one gets “income not as a reward for creating wealth but by grabbing a larger share of the wealth that would have otherwise have been produced without their effort.” And although this cannot be said of most of those in the 1% (I wrote about it a long time ago), it certainly does seem to be true for a considerable amount of those in the top. In the conference where I met Stiglitz, this was the main discussion, in fact – how many of those in the top around the world acquire their wealth through political connections (rent seeking) rather than via actual wealth creation. In other words the problem is that even though the pie is growing, a bigger and bigger amount of that pie is being captured by the rent seekers instead of the wealth generators. And that is indeed a huge problem. 

Another interesting part of the argument is the price we’re paying for inequality. Stiglitz goes beyond the trade-off between equality and efficiency stating that too much inequality is also bad for efficiency and bad for growth. He’s right, and it’s easy to see how – for one thing, having too many people left out of the benefits of economic growth derails their consumer spending power. I too have long considered the relationship between equality and efficiency to be non-linear, instead of just a simple trade-off. Too much equality isn’t good since it reduces incentives, but neither is too much inequality. I would say the relationship is of an inverted-U type where moving to both extremes – too much and too little equality is bad for the economy. The trick is to find an optimal point which reduces the level of inequality where it offers more opportunities for everyone, but also just enough for it to continue to drive incentives. More on that in my next blog post. 

Having said all this, there is still a feeling that the book lacks clarity in certain parts, as even within chapters it tends to jump from one argument to another. It gives the impression that it was either written too fast, that it was assembled quickly using some old writings, or even that certain chapters were written by someone else (several times he uses the “I” form, but in a few chapters there is also the “we” form, as in “our argument is…”). 

Plus there is often incoherency in the arguments. In the early chapters he claims that markets are not the principal driving force of the current status of the US, since all other countries are operating on the same market principals. His hypothesis is that the market forces are real but are being shaped by the political process that defines laws, regulations and institutions, all of which has some distribute consequences. Then in the closing few chapters he resorts to his usual bashing of the market forces and a cry for an omnipotent government to solve their failures. The biggest problem with this standard argument from the Left is that they expect the very same corrupt politicians, enslaved by their clientelistic relationship with powerful interest groups, be given even more power to supposedly fix the system. That’s why, in essence, redistribution is not the answer – given the issue of who is making the distributional decision. The answer is to change incentives (or “ideally” to elect someone like Stiglitz to lead us, right?). 

And then we come to the policy proposals; his grand economic reform agenda followed by a rather disappointing political reform agenda (disappointing given his excellent recognition of all the errors of the political system). Each is to be applied simultaneously in order to, well, create a better world, what else?! Reading these agendas (summarized on about 20 pages in the final chapter of the book) felt like reading a political program for a generic social-democratic candidate for president/prime minister. It was just a bunch of bullet points whose only purpose is to convey a positive message to the voters, rather than being a set of policies that can actually fix the system. Particularly when comparing them to Atkinson’s proposals, with whose details I also wasn’t really satisfied, but at least Atkinson made some effort into discussing the viability and applicability of each proposal. With Stiglitz, it all sounds just too cheap. For most of the proposals there isn’t a single sentence in how they are to be implemented, not to mention what the potential effects could be. Apart from the usual – if we implement all this we’re going to have a better society! It really is a mediocre political program. 

Now don’t get me wrong, some of the things he proposes in the book are quite good. I particularly agree with his criticism of “GDP fetishism”, given that GDP does not accurately reflect living standards, and particularly the sustainability of the economic growth model. Or the ideas to end corporate welfare (like hidden subsidies to big corporations and government giveaways in the form of procurement), to improve access to education, help Americans save (there is btw no indication as to how this is supposed to be done, but OK), expanding health insurance, improving the legal system, curb discrimination, etc. However others are just too much, or can be completely incoherent (like all of his proposals to curb the power of the financial sector – there is no indication as to how this was supposed to be done). Some are just breathtakingly shocking. For example I was bemused that a self-respecting economist can utter these words: “If exports create jobs, then imports destroy jobs; and we’ve been destroying more jobs than we’ve been creating” (pg. 279). Wow! A Nobel-prize winning economist succumbing to the most basic mercantilist fallacy by saying that imports destroy jobs is just unbelievable. You’re not running for President, Prof. Stiglitz, please do away with the conspiracies.  

However, I would still recommend the book even to those who usually disagree with Stiglitz, because if you can look past some of his standard ramblings, he really does deliver a decent analysis of some of the things that went wrong with the US political system.

Monday, 10 October 2016

2016 Nobel prize awarded to Hart and Holmstrom for contract theory

It's that time of the year again - Nobel prize awards! After being awarded to a single recipient two years in a row (Deaton in 2015, Tirole in 2014), this year the Nobel in economics is shared by two worthy winners, both relatively unknown outside the economic arena. The reason is that both Oliver Hart from Harvard, and Bengt Holmstrom from MIT, are theorists. What is their area of expertise? Contract theory, arguably the most complex field in modern economics. Which is why this year's prize is another laudable effort to commemorate this very important branch of economic theory for the very first time. 

So what's contract theory all about? Or to be more precise, what was the significance in their contribution? The official statement says the following: "Modern economies are held together by innumerable contracts. The new theoretical tools created by Hart and Holmström are valuable to the understanding of real-life contracts and institutions, as well as potential pitfalls in contract design ... This year’s laureates have developed contract theory, a comprehensive framework for analysing many diverse issues in contractual design, like performance-based pay for top executives, deductibles and co-pays in insurance, and the privatisation of public-sector activities."

Read a more detailed (layman) explanation here, and a more complex, theoretical one here. Also, here is a good text from Tyler Cowen. 

In a nutshell, contract theory studies how, in the presence of asymmetric information (adverse selection, moral hazard, signaling, etc.) do economic agents enter into contractual obligations. How do they create a mutually beneficial deal, that will incentivize both parties to keep their part of the bargain. Theorists examining contract theory try to find the optimal arrangement that will motivate agents to keep their commitment, even when entering the obligation with a veil of uncertainty. In other words, it's a utility maximization exercise, with time discounting and asymmetric information acting as the constraints. Examples of contractual relationships can vary from managers and shareholders, insurance companies and their clients, a firm and its suppliers, or between lenders and borrowers. 

The crucial part in designing an optimal contract structure is the satisfaction of divergent interests. In other words the contractual relationship must be thought of as mutually beneficial, otherwise no one would enter into one. It's a principal-agent game, to be more precise.  The issue is that the principal does not have perfect information on whether the agent is keeping to his side of the deal. A multitude of principal-agent examples have been researched in microeconomics, including labour economics, and political economy, and have mostly been modeled using game theory. One of the most famous principal-agent examples is the labour market: how does the principal (the employer) make sure that the agent (the worker) is not shirking? In a world of limited information the principal can never be too sure in whether or not the agent is performing his job as contractually obliged. In politics, the principals are the voters (the public), whereas the agents are the politicians. The voters "hire" politicians to do the job of running the country, but have very limited oversight into what the politicians are actually doing (notice that in dictatorships it is the dictator who is the principal, since he is accountable to no one). The example that Holmstrom used is the relationship between a company's shareholders (principal) and its CEO (agent) - how do the shareholders make the CEO maximize shareholder value instead of just their own compensation? 

Contract theory goes one step beyond modelling the pure principal-agent game. It is concerned with designing the optimal contractual structure to make sure that both parties benefit from the relationship and that neither has an incentive to shirk. It's all a question of risks vs incentives - which incentives will you offer the agent and at what cost? Examples include everything from performance-based pay structures to the extent of bonuses and stock options given to managers. The other important part, done by Hart, was to distinguish between complete and incomplete contracts, where the former are a theoretical construct, while the later are applicable to realistic settings, where the parties are unable to precisely articulate all the details ex ante. In particular, incomplete contracts are aware of the informational asymmetry and are concerned with the optimal allocation of control rights - which party should be given the decision rights (and how to compensate the other party), or should the decision rights be given to a third party? 

Needless to say the real-life application of these theoretical findings are primarily embedded in law (corporate law to be exact), particularly in the cases of property ownership, control rights, mergers and acquisitions, bankruptcy legislation, financial contracts, etc. This also means that their application is important for designing policy - the optimal bankruptcy laws, or property rights, and even privatization (how to strike a balance between cost reduction and quality). 

All in all, a welcomed award to a fascinating field of research. All the more so given that it was the recipients who designed this theoretical framework for others to build on. Congratulations to Hart and Holmstrom! 

Monday, 19 September 2016

The John Lewis economy - a belated comment

In my last book review I summarized a very interesting book called The Spirit Level by Richard Wilkinson and Kate Pickett. In it the authors propose a solution that would not only lower inequality and thus correct many of the negative social outcomes related to it (but not caused by it, mind you; they don't prove causality), but also change the entire system of values in society, so that people would be less profit-oriented and would increase their levels of interpersonal trust (among other things). 

Their big idea is to introduce democratic employee ownership. Hence the title: The John Lewis economy (the John Lewis Partnership is the famous UK example of an employee-owned firm; it allows all of its employees to share the firm's profits and have oversight over management decisions through several democratic mechanisms of corporate governance). It's a belated comment since I wanted to write a piece about this ever since 2012, when UK deputy PM Nick Clegg of the Liberal Democrats introduced the actual term "John Lewis economy". It was part of his policy proposal to introduce tax breaks to companies if they offered shares to their employees. 

Although the idea of employee-ownership is certainly admirable (it is easy to get 'hooked' on it), there are several problems with this model being forced upon the entire system and applied in every company. First of all, how would one enforce it? Clegg had the idea of offering incentives in the form of tax breaks. Fair enough, but as Wilkinson and Pickett (as well as many proponents of employee ownership) clearly state this is not enough. Employees have to have a more democratic say in managing the company, not just a share that doesn't mean much to them if everything still stays the same. They need to have oversight over management decisions (like voters do in democracies). That is at least how the John Lewis Partnership works. The problem is that the John Lewis Partnership developed and perfected this model through 80 years of its existence. It had the time to adapt and adjust its employee ownership model throughout this turbulent time. 

Another problem with such a proposal is the statement that "participation, commitment and control would be maximized if companies were 100 per cent employee-owned". And furthermore that "companies could raise capital through loans or mortgages retaining control for themselves", since only a small amount of money on stock markets makes any contribution to companies. This is very problematic on a number of levels. Removing access to various sources of finance for companies means condemning them on the mercy of commercial banks, to name only one consequence. The second is that this would severely undermine the dynamism of the economy as it would reduce their expansion capability, not to mention the ability to employ more people. Firms raise money in various ways primarily in order to expand, to service more customers, and - most importantly - hire more people! Without an ability to expand, or with this ability being seriously constrained, the economy would drastically reduce its dynamism, and especially its innovative capacity. The proposal to virtually abolish the stock exchanges is literary a reduction of modern society to pre-industrial revolution times, where the lack of economic growth implied less belief in the future and forced the economies to remain in a Malthusian trap for millennia. I understand there do exist a lot of successful co-ops out there, and this is perfectly fine. I encourage them to set up shop, expand and include more people in their networks. But one cannot enforce this upon the entire economic system as it would go against the evolutionary foundations of modern capitalism (within which we fought hard to attain the human rights we today take for granted). Having a fairer system is absolutely necessary. But you do not achieve fairness by shattering the spirit of growth and progress. 

Furthermore, one of the biggest arguments to impose employee-ownership is to change the for-profit mentality. This term is very often being confused with a battle for talent on a global level. You cannot compare the wages of local workers of a multinational company with its management. First and foremost because the demand and the supply for the two groups are different. Local workers are supplied and hired on the local market, whereas management is assembled from a national or even global pool of talents. Attracting the very best costs money. 

The same argument is with wages for athletes. There is a huge earnings differential between athletes in a single sport, and an even bigger one for athletes across all sports. Football players (both American and European - which I refuse to call 'soccer') are much better paid than volleyball or handball players. Even an average or below average football player in a good club may have a higher salary than some of the best players in other less popular sports. And this is perfectly normal given the greater demand for watching high quality athletes compete in the most interesting sports for the majority of people (football, basketball, baseball in the US, etc.), which necessitates that they be paid the heftiest sums. This is even more obvious for individual sports and their superstars - think of the top 10 tennis players, formula 1 drivers, or legends like Usain Bolt - who is to say he is not a great performer in addition to being one of the greatest athletes of all time? People pay extreme sums of money to buy tickets for Olympic game finals only to see Usain Bolt run for 10 seconds! And none of them consider this a waste of money. 

The bottom-up approach to solving the inequality problem

By far the biggest problem problem I have with many such proposals aimed at lowering inequality is the focus they tend to have on high incomes and the profit-motive mentality. The main proposals are usually aimed at increasing the top tax rates or curbing the profit motive of companies so as to make them more socially responsible. And although I agree that having more socially responsible companies would be a good thing, I don't think anyone should force companies to make choices they don't want to make. Nudging them in the right direction with smart regulation is much better. Having customers aware of the products made by socially responsible companies is another good example. There have been numerous examples where civil action against polluters or socially irresponsible companies made them change their business practice. The last thing any company wants is a bad reputation. Now they must compete in their social responsiveness in addition to their prices and product quality.

To return to my initial point, why isn't any anti-inequality advocate focused on a bottom-up approach? Why aren't many policy proposal focused on the poverty side of inequality. After all, the variety of health and social outcomes linked with inequality can easily be attributed to poverty, like crime and violence, poor education performance, teenage pregnancies, imprisonment, selected health and mental issues, etc. In other words, if we can make the poor richer and better off by turning more of them into the middle class, we would surely be reducing inequality and simultaneously improving a variety of health and social issues, without imposing potential damage of wealth creation at the top. In fact, having high incomes can only serve as a motivation for people to invest in their education and abilities to achieve the same high living standards. A whole different problem is if the people are being prevented from upwards social mobility if they don't belong to a particular class, gender, or race. This is an issue any anti-inequality advocate should look into since low social mobility (caused primarily by cronyism and elite entrenchment) is arguably the biggest obstacle for lowering inequality - it prevents access on the low levels of society and thus immediately discriminates those on the low end of the earnings distribution.

Fighting poverty, in my opinion, is the most effective way of fighting inequality. Primarily since there are many more poor people out there than rich people. Helping all of them get higher earnings will necessarily solve many of their social issues as well. I understand the psychological factor of anxiety by seeing someone being so much more well off, however this mentality is perhaps a greater concern that the profit-motive one. Why should one care so much about the wealth of others? Because we only value our own success compared to other people's success. Ever more so in today's dynamic era of fast information. I still feel however that the resentment towards the well-off would be contained (but not eliminated) if we eradicate poverty. This remains to be scientifically tested. 

Finally, if you want to build a more egalitarian society than the first thing where to look is among existing egalitarian societies - like Scandinavia, Canada, or Japan. What makes them so successful? Mass employee ownership of private sector companies? The US and the UK have 10 times more employee-owned firms than all other countries in the world put together (don't believe me? See for yourself). So having employee ownership is not that crucial to achieve a more egalitarian society, is it? What is? Economic freedom is one thing. Look it up.

Wednesday, 14 September 2016

What I've been reading (vol 10.): Cronyism and inequality

Zingales, Luigi (2012) A Capitalism for the People. Recapturing the Lost Genius of American Prosperity. Basic Books, New York.

Luigi Zingales, a University of Chicago Booth School of Business professor of finance, is one of the true champions of liberal, free market ideas. In this book, similar to his previous success “Saving Capitalism from the Capitalists” (co-authored with Raghu Rajan), he delivers a powerful case in favor of markets, competition, liberty, and against big business, big governments and their clientelistic (cronyist) mutually beneficial relationship. In other words, Zingales knows the crucial and very important distinction between being pro-business and being pro-market. Confusing one with the other is a typical mistake every advocate of socialism tends to make – they tend to blame capitalism, markets, and the ideology “neoliberalism” for close ties between politicians, big businesses, and the media. Zingales correctly points out that this is hardly the case. If anything their relationship is a perfect example of cronyism – receiving government favors based on close personal relationships, not to mention things like corruption, nepotism, clientelism, conflicts of interest, bribery, and even something called institutional corruption (implementing laws that benefit partial interests of public or private enterprises, usually by handing out monopoly power). None of this has anything to do with competition. None of this has anything to do with classical liberalism, with Adam Smith, or free markets. And it is exactly competition and the classical liberal tradition that are at the forefront of Zingales' book. 

He opens the book with a personal touch. His story of how he wanted to escape what he calls a “fundamentally unfair” system in Italy, riven with nepotism, where meritocracy doesn’t exist (grades apparently don’t matter for enrollment into university), where political affiliation is the basis for promotion in any public sector job, where the only way to get rich is to be politically connected and receive government contracts, where mothers marry their daughters into power as a means of social promotion, where young people need to “carry the bag” for those on higher positions of power in order to get ahead in life (this is how the academia in Italy apparently works – you can only achieve promotion when the older professors retire or die – whichever comes first!). When he came to America in 1988 he was overwhelmed by the opportunities available to him. He had finally arrived in a country where his ability was the only limit to his dreams, not the people he knows. After all, as Zingales correctly emphasizes, Americans, whether Democrats or Republicans, “have no idea what it’s like to live in a country where there is virtually no meritocracy and competition is considered a sin.” 

Having this life-altering experience, Zingales is worried that the same forces that have occupied his native Italy for so long (and still do) are now grabbing steam in the US. He describes crony capitalism, American-style, where pro-business interests have vastly taken over pro-market and pro-competition incentives, where both businesses and the government have grown too big and too gruesome, and are now jeopardizing the very stability of the country. In other words, Zingales is overseeing the transformation of the US free market system into Italian-style crony capitalism. 

Nowhere is that more obvious than in finance. Too-big-to-fail banks being bailed out using public money; those same banks paying out huge bonuses to their executives in times of heavy losses imposed to the public (privatized profits, socialized losses); corporate lobbyists influencing legislation and regulation as they please; the list goes on. It was the scandals causing and arising from the biggest crisis since the Great Depression that led many people in the US to distrust markets and rebel. Voters lost confidence in the system they perceive to be elitist, corrupt, rigged against them, and unfair. No wonder they can easily resort to populism. And who could blame them when the self-defeating cycle has become obvious even to the layman: former politicians and former public officials, once they leave office, get fat paychecks in the private sector they once regulated. It’s a typical quid-pro-quo relationship and it’s ruining the foundations of American capitalism. 

Two political movements have arisen as a consequence: on one hand the Occupy movement opposing Wall Street’s too-big-to-fail attitude, and on the other the Tea Party, opposing taxes and big government, which arose partially as a response to the crisis. Interestingly both of these movements yielded political figures 6 years after they started. Bernie Sanders, the 'democratic socialism' hero, got attention as a clear consequence of the Occupy movement (he shares their messages and concerns), while on the other hand there is Donald Trump, a clear consequence of the Tea Party movement (also sharing their anti-immigration, protectionist, and against big government messages). 

Both of these movements are right in their own narrow way. But they fail to realize that their different enemies (big business and big government) are two sides of the same coin. Big business getting exclusive deals and monopolistic positions from the government; a government and congress riven with hypocrisy and highly prone to corruption – these are both typical signs of crony capitalism. Another thing both movements got it right is that the establishment elite has failed the system. They have allowed it to become cronyist, to become overburdened with the satisfaction of partial interests. In fact they themselves have become the key pillars of a crony system. 

So what does Zingales propose how to fight this? He calls for a seemingly paradoxical promarket populist agenda. He calls for a populist movement similar to the Populist Party of the late 19th century which never really achieved any major electoral victory, but it did help influence many of Theodore Roosevelt’s reforms like antitrust laws or accounting transparency. The idea is then to channel populist anger into fighting cronyism and the corrupt elites, not to destroy the foundations of American capitalism. A socialist would say these are synonyms. Far from it. Zingales cites numerous examples in this book of how cronyism is a natural enemy of the competition-based libertarian pro-market position. When businesses succeed based on their connections and political favors instead of their competitive advantages, there is simply no sign of markets. The idea of liberal capitalism vehemently opposes the concept of cronyism. Zingales goes a long way in proving how this is so.

Jones, Owen (2014) The Establishment. And how they get away with it. Penguin Books.

What can I say about this one? The first thought that comes to mind is – conspiracy theory. The book is a typical Marxist propaganda pamphlet full of personal biases of the author which he cannot seem to shake off in order to provide a balanced view; a book in which the author shows some basic misunderstanding of the patterns of economic history (which is a shame given that he majored history at Oxford); and finally a book that feels like an Ed Milliband Labour party manifesto (or even better Jeremy Corbyn’s Labour party, since Milliband was obviously too soft according to the author, whilst Blair is just another evil Thatcherite – see where I’m going with this?). It’s really a shame given that the title and the initial description of the book were so promising. I was expecting this to be a decent overview of how the British establishment has failed to prevent and eventually succumbed to cronyism, and how this is threatening the very existence of British democracy (so essentially a similar read to Zingales). But I was left entirely disappointed as the author kept making numerous false assumptions, kept writing in banter style, kept insisting that the Establishment is this all-powerful organism that shapes the foundation of our lives and forces the people to do things against their wills without even knowing it. It is unfortunate that the author cannot shake away his own very strong biases, as some of his investigations and analyses are actually quite good and accurate: the stories of big businesses feeding of government subsidies, the corruption of the media (the Leveson inquiry scandal), the financial elite, the police, and of course the politicians themselves. But all of this is wrapped around in a tin foil of banter against everything and anything conservative (it’s fine if you want to criticize conservatives, but this was not a criticism, it was honest hatred), and even free market oriented intellectuals which the author derogatorily refers to as the Establishment’s outriders.

Yet it had so much potential. According to the author the Establishment, a sparsely defined amalgamation of everything evil on this planet, depends on several things to feed itself (it’s almost like the Leviathan, although it’s quite obvious why the author refuses to use that particular term): they need support from the media and political elites (which are sometimes both the establishment themselves and sometimes they are just advocates of the current order), they rest upon ideological support from public intellectuals (right wing, mind you), the police (the extended hand of the establishment, not the law), and of course is consistent of big business that although supporting the “neoliberal” ideology wouldn’t survive without government subsidies (this one is actually a very good point, however it has nothing to do with markets – see the previous review). 

It’s fascinating how the author has complete disregard of facts and how he tries to fit every piece of information into his narrow worldview. For example, he constantly cites opinion polls (I assume filled out by Guardian readers) saying that the vast majority of the people support nationalization of public sector companies, or the re-imposition of capital controls, or the strengthening of the labour unions (so in effect, revoking all of Thatcher’s policies from the 1980s). However, given the recent electoral outcomes (2015 elections and the Brexit referendum) and the upcoming disaster for Labour under Corbyn (which, I would assume, the author would denounce and bravely and blindly argue that Corbyn will be the next PM), it’s hard to conclude that the “majority” of Britons would support Ed Milliband’s soft socialism or particularly Corbyn’s hard socialism. They haven’t done this since the 1970s and given their current sets of preferences I don’t see any reason as to why they would revert to it. But that’s the media’s fault according to Jones. The media, which vehemently supports the Establishment, carries out its important role in biasing electoral campaigns against the Establishment’s (read: the Conservative party’s) opponents. The media is therefore responsible (along with the neoliberal ideologues, mustn’t forget them) in biasing the public opinion and their vote choices against socialist policies (moving the “Overtone Window”). This conclusion is another example of a logical fallacy committed by the author: if the media and neoliberal ideologues form public opinion and their voting choices, how come certain polls allegedly show that public opinion is in favor of socialism? Shouldn’t the people then overwhelmingly support socialism come election day? Are they being brainwashed perhaps? If so, if they are being brainwashed by the neoliberal dogma, why do they lie in the polls saying they want socialism? What is going on?!

Too bad the book was written before the 2015 elections and the recent EU referendum, since I would be interested to see which line of reasoning the author would use for explaining their outcomes. Before the generals in 2015, every newspaper was talking about a split Parliament, many of which were saying Labour will be taking a close victory. Guardian columnists were even considering a Conservative-Labour coalition. In the end Conservatives won by a 6-point landslide. On the EU referendum every mainstream media supported Remain. One could actually say the Establishment supported Remain. But the author is clearly also a Remain supporter (perhaps he changed his mind recently). I wonder how all this would fit into his biased media angle. 

These are just a few examples, there are many more that are outright contradictory and sometimes even ridiculous and amusing. At one point he even says that because of Labour and Conservatives looking so alike voters have started to look elsewhere, like the Green Party! I kid you not, he says “growing support for the Greens” in addition to rising support for SNP and UKIP will make the first-past-the-post system untenable. Or how he claims that the 1970s produced the “most stable economic growth ever” along with a “staggering increase in living standards”. 

All in all, the author, just like most socialists, fails to understand the basic difference between capitalism and cronyism. To the typical champagne socialist there is no difference. Zingales, in the previous review, made an excellent point here – cronyism is the natural enemy of capitalism. It consumes it and takes on the worse form of capitalism – an interlock between vested corporate interests and the political elites undermining democratic order. A failure of democracy, so to speak. A socialist would argue that cronyism is a natural outcome of capitalism. I heavily disagree since cronyism is hardly limited to capitalist societies. In fact, cronyism tends to be highest and almost necessary in dictatorial societies, most of which are governed by socialist regimes. All in all, I wouldn’t recommend the book if you are already familiar with the standard champagne socialist bullshit. Pick another book instead. Like the next one.

Wilkinson, Richard and Pickett, Kate (2010) The Spirit Level. Why Equality is Better for Everyone? Penguin Books

Here is another left-wing piece of literature, however I find this one to be incomparably more convincing and persuasive than the previous book, despite the many issues I have with some of the arguments. Mainly it’s because the authors in most cases use real scientific studies to back their claims, and use actual data to support their main argument – that rising inequality is likely to be responsible for a whole number of negative outcomes depleting our social capital: from the rising lack of interpersonal trust, to physical and mental health problems, to violence, obesity, teenage pregnancies, and social mobility. The authors don’t prove causality (they correctly point this out) but do imply causality on several occasions, which is the biggest problem I have with the conclusions of the book.  

Both authors are epidemiologists and have done years of research in observing health outcomes in rich OECD economies, yielding a conclusion of rapidly deteriorating health levels of modern societies, linking many of these to the ills of inequality. Some of these links may be a bit farfetched (the evidence in favor of them is unconvincing at best), but some are quite fascinating and very likely to be true.

Which are the negative outcomes related to inequality then? First there is interpersonal trust, followed by a host of mental illnesses (including drug and alcohol addiction), then life expectancy, infant mortality, obesity, children’s educational performance, teenage births, homicides and violence, imprisonment rates, and finally social mobility. In a chapter-by-chapter analysis the authors present their case for each of these outcomes being somehow related to rising inequality. Their general conclusion when comparing OECD economies and US states is that more unequal countries (states) tend to have worse health and social outcomes. The evidence they provide is of a visual type – correlation graphs. Which is where the problem arises. Correlation graphs are filled with endogeneity issues – there is no way to use a series of correlation graphs to prove or disprove reverse causality or omitted variable bias. In simpler terms correlation does not imply causality, no matter how strong the links tend to be. Correlation can indicate a relationship, but that relationship needs to be proven with experimental research to make any inference of potential causality. Just placing a bunch of graphs that supports their general argument does not do the authors any favors.

However, a big part of the argument that supports the link between inequality and poor health and social outcomes comes from chapter 3 in which they cite the psychological reasons and rising anxiety tied with greater inequality. This is supposed to be the glue holding the later arguments together and tying each of them to inequality. The pure fact that we as humans tend to link our happiness not to our absolute wealth or living standards, but to our relative position in social and income hierarchies (the feelings of pride and shame), is the line of suggestible reasoning used by the authors to make their claims. I’m not saying this line of reasoning is wrong, I am only saying this part of the argument is left entirely under-researched in the book. The implication is there, but the proof is missing. 

I have paid careful attention in the argumentation where they cited actual research and where they didn’t, and the difference is obvious. For example, citing research on educational performance of children based on experiments proving how different social class affects performance are absolutely convincing in proving their argument. In this particular case they cite the experiment from World Bank economists who compared high caste and low caste 11 and 12 year old boys from India. When the groups were not aware of each other’s caste they performed almost the same in the tasks they were given (in fact the low caste group slightly outperformed the high caste one). But when they were made aware of the caste differences the performance of the low caste group significantly deteriorated. The same was found when comparing the performance of white and black students in the US when black students were told the test was a measure of ability. Or an even better one where a US schoolteacher used her students as test subjects by telling them that blue eyed people were much more intelligent than brown eyed and gave them extra reinforcements. The difference in outcomes was significant, not to mention the blue eyed kids asserting superiority, but it was all immediately reversed when she told the students she made a mistake and that it was the brown eyed kids who were actually smarter. Now the brown eyed took over. 

The authors conclude: “performance and behavior in an educational task can be profoundly affected by the way we feel we are seen and judged by others. When we expect to be viewed as inferior, our abilities seem to be diminished”. Neuroscientific research finds additional evidence in terms of hormones released when we are feeling confident and happy in oppose to those released when we feel threatened or stressed, all of which would boost or downgrade our performance. The inequalities resulting from social stratification and class struggle are obviously affecting poor performance of those at the very bottom of the social pyramid making them further entrenched at the bottom. This is indeed a big social issue. 

However in other examples, when the evidence was mixed at best, the authors tend to push the argument towards their own worldview. This is the biggest resentment I have towards the book, which is a shame since it had potential to provide a broad and unbiased argument on the topic, especially since it shies away from strong, subjective language and reasoning. One still can’t escape the fact that in some lines of reasoning it is bleak at best.

In particular in some cases the correlation between two variables, no matter how close it is, is probably not the consequence of causality between the given two variables (inequality and a corresponding social outcome), but possibly both are caused by a joint factor – something that increased both inequality and, say, led to the rise in obesity, anxiety or the lack of trust, simultaneously. We are therefore talking about a hidden factor causing both outcomes to arise, where they can further reinforce each other. I do believe that high inequality reinforces all the mentioned social problems, but I don’t think it is necessary the cause of each and every one of them. Some of them perhaps, but not all. 

Furthermore, most of the issues are actually heavily (although not exclusively) related to poverty. E.g. crime and violence, imprisonment, teenage pregnancies, some aspects of physical and mental health, educational performance (richer parents spend and invest more time with their children and are determined at helping them succeed whereas poor parents are more preoccupied with survival), etc. However the authors seem adamant in claiming that poverty alone cannot explain all of the negative social outcomes they link to inequality. They suggest that inequality brings an equal burden on to the middle classes as well as the poor. In fact more unequal societies have worse health outcomes across all income groups, not just the poor. The authors make a particularly strong case for this in chapter 13 by comparing the incidence of various diseases, life expectancy, and infant mortality in more and less unequal societies across all income groups. It does seem to show that less unequal societies are better across the board. But, and this is important, this does not prove that it is inequality that CAUSES these differences. Nor does it prove that poverty is the cause. In the same chapter (as well as in the postscript of the 2010 edition of the book) they pay closer attention to the causality issue and even though they admit that “association on its own does not prove causality and, even f there is a causal relationship, it doesn’t tell us what is cause and what is effect.” I couldn’t have said it better myself. But this doesn’t prevent them from imposing causality later in the book, particularly in the final chapter where they take their argument for granted by saying that “observational research can still produce a powerful science” and that the “relationship between inequality and poor social outcome is too strong to be attributed by chance alone”. 

The problem with thinking about correlation this way is not being able to think that both inequality and many of these negative social outcomes can perhaps be affected by a joint unknown factor that is causing both of them to increase in countries like the UK, US, or South Europe. Or perhaps they aren’t, we cannot know for sure. Or maybe all of these outcomes (inequality, poverty, poor health) are mutually reinforcing, so we have to establish what caused them to emerge. Not until we have concrete evidence (such as the research on educational outcomes related to social status) that inequality, poverty, or something else is leading to the rise of negative health and social outcomes in more unequal societies. For example, their aforementioned idea that anxiety due to our relative performance and social status makes us so sensitive to inequality which is why we react so negatively to it. Perhaps the causes of anxieties in more unequal countries are related with migration, the expansions of population and rapid urbanization of the post-WWII era where the feeling of being alone and worthless is likely to be amplified, particularly in large cities (which also, btw, reduces trust). This could reinforce all the health and social outcomes, which lowers social mobility and as an effect pushes inequality up. This is an idea out my head but it cannot be proven or disproven without concrete evidence. 

The authors' biased worldview disables them for thinking about these issues in much greater detail, which is unfortunate. At least that's the feeling you get from reading the book. It is a good read, and it does uncover some striking facts, but it fails to connect all of them in a more coherent way. It doesn’t prove what the authors think it proves: that inequality is the “common denominator” behind an array of negative health and social outcomes. It establishes very interesting food for thought, but much more research needs to be done to make this conclusion viable and correct.