Tuesday, February 24, 2015

Competition Is Wasteful

Related to last time, this article on expenditure cascades, Why have weddings and houses gotten so ridiculously expensive? Blame inequality (Vox), talks about the ways that positional goods and extreme inequality cause waste in various economies:
The median new house in the US is now 50 percent larger than it was in 1980, even though the median income has grown only slightly in real terms. Houses are growing faster than incomes because of a process I call "expenditure cascades."

Here's how it works. People at the top begin building bigger houses simply because they have more money. Perhaps it's now the custom for them to have their daughters' wedding receptions at home, so a ballroom is now part of what defines adequate living space. Those houses shift the frame of reference for the near-wealthy — who travel in the same social circles — so they, too, build bigger.

But as the near-wealthy begin adding granite countertops and vaulted ceilings, they shift the frames of reference that define adequate for upper-middle class families. And so they begin going into debt to keep pace. And so it goes, all the way down the income ladder. More spending by the people who can afford it at the top ultimately creates pressure for more spending by people who can't afford it at the bottom.

The best response might seem to be simply to exhort people to summon more discipline, except for the fact that...
3) The costs of failure to keep pace with community spending norms are not just hurt feelings

The process I describe isn't a law. Congress isn't mandating that people buy bigger houses. So if it's optional, why don't people simply opt out? Because opting out entails real costs that are extremely hard to avoid.

Failure to keep pace with what peers spend on housing means not just living in a house that seems uncomfortably small. It also means having to send your children to inferior schools. A "good" school is a relative concept, and the better schools are almost always those in more expensive neighborhoods.

Here's the toil index, a simple measure I constructed to track one important cost of inequality for middle-income families. To send their children to a school of at least average quality, median earners must buy the median-priced home in their area. The toil index plots the monthly number of hours the median earner must work to achieve that goal. When incomes were growing at the same rate for everyone during the post-World War II decades, the toil index was almost completely stable. But income inequality began rising sharply after 1970, and since then the toil index has been rising in tandem. It's now approximately 100 hours a month, up from only 42 hours in 1970.

The median real hourly wage for men in the US is actually lower now than in the 1980s. If middle-income families must now spend more than before to achieve basic goals, how do they manage? Census data reveal clear symptoms of increasing financial distress among these families. Of the 100 largest US counties, those where income inequality grew most rapidly were also those that experienced the largest increases in three important symptoms of financial distress: divorce rates, long commutes, and bankruptcy filings.

In OECD countries, higher inequality is associated with longer work hours, both across countries and over time. Standard economic models predict none of these relationships.

4) Positional concerns spawn wasteful spending patterns, even when everyone is well-informed and rational

Charles Darwin, the great British naturalist, was heavily influenced by Adam Smith and other economists. He saw that competition in nature, like competition in the marketplace, often produced benefits for both individuals and larger groups, just as in Smith's fabled Invisible Hand theory. Keen eyesight in hawks, for example, made both individual hawks and hawks as a species more successful. Yet Darwin also saw clearly that many traits and behaviors helped individuals at the expense of larger groups. When success depends on relative position, as it almost always does in competitive struggles, wasteful positional arms races often result.

Consider the antlers in modern bull elk, which span four feet and weigh as much as 40 pounds. Because they impair mobility in wooded areas, bulls are more easily surrounded and killed by wolves. So why doesn't natural selection favor smaller antlers? Darwin's answer was that large antlers evolved because elk are a polygynous species, meaning that males take more than one mate if they can. But if some take multiple mates, others are left with none. That's why males fight so bitterly with one another for access to females. Mutations that coded for larger antlers spread quickly because they made any bull that had them more likely to win.

But bulls as a group would be better off if each animal's antlers were smaller by half, since they'd be less vulnerable to predators, and each fight would be decided as before. The inefficiency in such positional arms races is exactly analogous to the inefficiency of military arms races. It's also like when everyone stands to get a better view: no one sees any better than if all had remained comfortably seated.

Beyond some point, additional spending on mansions, coming-of-age parties, and many other goods becomes purely positional, meaning that it merely raises the bar that defines adequate. Because much of the total spending in today's economy is purely positional, it is wasteful in the same way that military arms races are wasteful.
This is one reason highly unequal societies are always less successful than more equal ones. Add to the fact that human capital is developed much more broadly in equal societies, and there is more opportunity for everyone in equal societies rather than just a hereditary elite.

The article mentions that the rich, too, would be better off without having to play keep-up with this arms race, and higher taxes would accomplish this with no downside since the additional income to the rich is now just being used for competition with other elites, rather than productive investment, and causing the costs for everybody to rise (especially for housing). Of course it will never happen, since the American rich are uniquely sociopathic, and will never rest until they have every penny and have to step over the dead bodies to get to their twentieth mansion.

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