Economics in Two Lessons, Chapter 13

Thanks to everyone who commented on the first twelve chapters of my book-in-progress, <em>Economics in Two Lessons</em>.

Here’s a draft of Chapter 13 on Redistribution

Comments, criticism and praise are welcome.


Earlier draft chapters are available. These aren’t final versions, as I am now editing the entire manuscript, but you can read them to see where the book is coming from.

<a href=”″>Table of Contents</a>
<a href=”″>Introduction</a&gt;.
<a href=”″>Chapter 1: What is opportunity cost?</a>
<a href=”″>Chapter 2: Markets, opportunity cost and equilibrium</a>
<a href=”″>Chapter 3:Time, information and uncertainty
</a><a href=”″>Chapter 4:Lesson 1: Applications</a>.
<a href=”″>Chapter 5: Lesson 1 and economic policy</a>.
<a href=”″>Chapter 6: The opportunity cost of destruction</a>
<a href=”″>Chapter 7: Property rights, and income distribution</a>
<a href=”″>Chapter 8:Unemployment</a>
<a href=”″>Chapter 9: Market Failure</a>
<a href=”″>Chapter 10: Market failure -Externalities and pollution.</a>

<a href=”″>Chapter 11: Market failure: Information, uncertainty and financial markets</a>

<a href=”″>Chapter 12 on Predistribution</a>

Feel free to make further comments on these chapters if you wish.

5 thoughts on “Economics in Two Lessons, Chapter 13

  1. I liked the externalities chapter – direct and full of insight. Some novel ways of looking at things too.

    I don’t know whether you want to discuss the issue of why externalities and public goods arise. It is related to the transactions costs of organizing markets and of doing deals. The prescriptions by (i) Arrow et al in the 1960s that the problems of missing markets can be resolved by creating them and (ii) of Coase that direct bargaining can resolve these issues, both always seem to be avoiding the issue that the existence of these transactions costs raises. These prescriptions ignore the central problem and put the onus back on direct regulation. An alternative interpretation of Coase – that it is mainly concerned with understanding the transaction cost obstacles to doing deals is a more profitable view. Then establishing property rights via courts of law and perhaps subsidising class actions to reduce free rider obstacles can be seen as devices for reducing the transactions costs that prevent deals being done.

  2. 13.1:
    A diagram showing “In this case, there may be no wage lower than the employer’s benefit from the job, but high enough, net of the effective marginal tax rate to offset the workers opportunity cost.” would make this much easier to follow. Especially if it is compared with the effective marginal tax rate of high income individuals.

    “Moreover, in thinking about foregone opportunities for beneficial trades, the social benefits of additional consumption for high income earners are small. So, the primary focus must be on the potential loss on the other side of the transaction. “ Huh? This does not explain clearly to laymen like me.

    Most of this section is making a point about marginal tax rates on the poor being too high. That should not be here at the beginning of the chapter.

    “So, to transfer $1 billion to SNAP recipients, it is necessary to raise more than $1 billion in additional revenue. “ This can be misunderstood as to mean you need to raise a total of $2 billion. But how much is is really? Note that these costs are inescapable for ANY business revenue, charitable donations, etc: they are not unique to taxation. They are a part of ANY transfers, public, private, for-profit, non-profit.

    “This change in opportunity costs, often referred to as an ‘incentive effect’ means that high income earners will tend to allocate less time to work, and more to leisure, when tax rates are increased. “ That is a One Lesson fallacy according to “Does Atlas Shrug?: The Economic Consequences of Taxing the Rich”.

    “constructs derived from economics are often used, implicitly or explicitly, in ways that imply that an additional dollar of income should be regarded as equally valuable, no matter to whom it accrues. “

    Rant ON:
    Which is because economics usually does not measure non-monetary benefits: health, happiness, comfort, capability. These are limited by the bodies and minds of individuals. Corporations, because they have no bodies or minds, can only measure their benefits monetarily and have no limits on monetary benefit.
    Money is a proxy for values, and a very poor one.
    “Liberty and equality, spontaneity and security, happiness and
    knowledge, mercy and justice – all these are ultimate human values” Berlin
    Wealth is a corporate value, which is why we can think of corporations as demons: they have inhuman values as well as being immortal, amoral, more powerful, etc.

    The purpose of an economy is to satisfy human values. One of the most insidious aspects of Econ 101 thinking is that human values can be represented by money. Opportunity costs measured in human values would give an entirely different result. Hence the capabilities approach.
    Rant OFF.

    Arithmetic means and geometric means and measuring by money ALL presume that values are satisfied linearly. But they are not: there is diminishing marginal returns as various values are satisfied. This is intuitively obvious to most people, and in general has been the subject of much game-theoretic study.

    “The most obvious opportunity cost is the reduced income of those who pay the extra tax. However, as was argued in Section 12.8 in a society with highly unequal incomes, and with moderately egalitarian attitudes, this opportunity cost will be negligibly small; we are trading off increases in luxury expenditures against the capacity to meet basic needs.”
    Here you switch to my values idea. But this is not commensurate with your other measures of opportunity cost, and you do not make that clear. That’s the cool thing about Rawls: he divorces from monetary measures.
    However, this is NOT TRUE if we are talking about corporations, business or indoctrinees into Econ 101. They consider monetary value to be the sole measure of opportunity cost.

    Many of your sections could benefit from a leading paragraph that presents the conclusion, making the rest of the section an explanation of the conclusion. 13.4 for example.

    “* Limit corporate monopoly power, particularly power based on intellectual property;”
    It would be nice to have a short list of such limits, such as: shorter terms, different presumptions, etc.

    Many other limits on corporations could be mentioned: legislative reduction of their rights, worker representation on boards with rights to investigate practices, etc.

    Over all, this chapter might have problems because redistribution is generally from two very differing classes: the wealthy and the corporations. They are not synonymous, though they do overlap.

  3. Chapter 13 provides a coherent view of the effects of tax changes on redistribution. Perhaps too coherent given the real lack of convincing evidence on labour supply elasticities and the stark divergences in various approaches to this issue. The modern literature on “optimal income taxes” that you cite presents a very particular view. The point about the diminishing marginal utility of income is correct as are doubts about the social value of high-income work but these are not the relevant issues for deciding on high-income tax rates overall tax progressivity versus flatness. The main issue is that high-income people do pay the bulk of income taxes and hence underwrite the redistribution mechanism. Even if work disincentive effects are modest it is because they impact on a lot of income that they have a large effect on the capacity to redistribute. This is a reason to take care with marginal rates impacting on the wealthy. Many favour a flatter tax system for this reason – if tax rates are thereby high on low-income earners the cost in terms of foregone work effort is low if these low-income workers have low productivity and if they can get plenty of income funded by the rich who are not on punitive marginal tax rates. I recall that in the early Mirrlees paper that orginally developed this line that Mirrlees didn’t like this conclusion at all (it does seem unpleasant) but it is what his analysis suggested. If you are uncertain about labour supply elasticities – as I pretty sure we are – the original Mirrlees argument is strong. Pushing for what can seem to be strongly redistributive taxes via high marginal tax rates on the top 1% can be a bad move. Better a relatively flat tax system with large redistributions.

  4. The Fair Work Ombudsman’s Office occasionally surveys businesses for compliance with minimum award and National Employment Standard conditions. The level of compliance is not good. I’m guessing the real level of compliance is much lower than revealed by the FWO because some businesses will bluff their way through the inspections and some workers will lie about their situation because underpayment and exploitation beats the dole or deportation (a real possibility for many OS employees).

    Accordingly the “predistribution” system to which John refers to is a very leaky bucket. Nonetheless, it is better than nothing. Without it, inequality would be even worse.

    If anyone thinks the FWO does a good job they should reflect on the fact that the 7 Eleven franchise underpayment and payback scandal was cracked open by a Good Samaritan who listened to exploited 7 Eleven workers’ stories and went in to bat for them. This led to the Four Corners story that made it all public. A flaccid FWO only flexed its puny muscles after its nose was rubbed in stink of this scandal.

    We now know, thanks to the financial services royal commission, that many franchise operations make it near impossible for franchisees to pay workers legally. Some even tell franchisees to hire vulnerable workers so that they can more easily be exploited and underpaid.

  5. Chapter 8 on unemployment was good. A couple of minor points.

    Unemployment you introduce as a “coordination failure” and a problem of deficient demand. You did not identify precisely how these things link up.

    Very minor: 1930s Depression due to a stock market crash which led to lower demands which created unemployment and, as you see it, a financial/banking crisis. I think the links here is direct: Stock-market crash => financial crisis and lack of demand.

    The para :however, the majority response, among microeconomists, has been…” I found a bit obscure. Particularly the second last sentence. Not clear what the evasion is here though may be my denseness.

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