This Is the End


Markets, Risk and Human Interaction

October 21, 2011

Occupy Wall Street, Social Unrest and Income Inequality

We are seeing the specter of instability in the growing protests of income inequality, economic distress of the middle class, and economic and political power of the very wealthy. There is Occupy Wall Street in the U.S., and similar protests ranging across the globe. In parts of Europe there is rioting in the streets, in parts of China protests have turned deadly.

A microcosm for these protests can be seen in Israel, which is among the first of the countries to stage such protests. In a one of my recent posts, "Workers of the World, Goodnight!", I recount my experience in the egalitarian Israel of the early 1980s, and contrast that with the Israel of today, where a handful of families basically have a controlling interest in the economy proper, and where the concentration of wealth at the top makes the U.S. look like a commune. This transformation over the past few decades tells us something about the roots of social unrest that have spread recently from Occupy Wall Street to other countries. The Israeli society that I saw three decades ago was one that faced the unrelenting specter of war. During times of crisis, of war or natural disaster where there is a randomness to existence that extends beyond wealth to issues of life and death, people choose to be more egalitarian. People know they might end up with the short end of the stick with the next roll of the dice, and that whatever they acquire will likely be transitory. So they first and foremost focus on keeping a social system and its support structure in place.

Unerring stability leads to the opposite course. For example, in the medieval societies where position remained unchanged for decades, even centuries, where land, the key source of wealth, passed inexorably from one generation to the next, where class distinctions dictated the path of your life and that of your children, an egalitarian notion was not even in the realm of consideration. There were the rich and there were the poor. It was as simple as that.

Absent a policy of income redistribution, capitalism plus stability leads to income disparities. Take stability out of the equation, and the distribution will narrow. Israel is more stable thanks to the efforts of the broad base of society, most notably through their military commitment And so Israeli society as a whole maintains the environment that allows the remarkable income disparity to occur. Because of this, Israeli society as a whole questions the social structure that gives rise to this disparity. They have a hand in creating that stable society, and could theoretically choose instead to move more toward one of instability. In the extreme case, doing so might be their best course.

A Reworking of Rawls' Theory of Justice
In The Theory of Justice, Rawls performs the thought experiment of developing a political system where those determining this system are operating under what he calls the veil of ignorance. The veil of ignorance prevents the contractors – those who are going to enter into the political contract that they have a hand in developing – from knowing their place in the resulting society. They do not know their assets, their endowments of intelligence and strength, even many of their preferences and values. They do not know their place in society, they do not even know the civilization and culture that has been achieved.

The veil of ignorance is an important vehicle for the development of his political theory. The exercise is trivial without it. If one's endowment is known at the time political system is being crafted, then obviously the endowed will push toward a winner-takes-all system while those on the other extreme will push for an aggressive redistribution of wealth.

The epistemological constraint imposed by the veil of ignorance creates the circumstances for the contractors to act in accordance with Rawls' fair principles, which include: The contractors cannot choose to advantage just themselves (since they do not know where they will fall in society); they cannot choose to risk massively disadvantaging others (because these others will defect); and they cannot risk massively disadvantaging themselves (because they must consider their descendants and their own capacity to stay true to the principles they choose). Thus, even if the contractors do not affirmatively seek fairness, their circumstances lead what they choose to end up being fair.

From their perch in the original position behind the veil of ignorance, Rawls' contractors seek to temper the worst possible outcomes. We might think of this as the contractors choosing a basic structure for society in which there position will be randomly assigned, or even where there is a chance that their enemy will assign them their place. Rawls offers several reasons why this is the natural result. First, the parties cannot rationally take risks because the veil of ignorance makes probabilistic calculations impossible. Second, the contractors are choosing the political system not only for themselves, but for their progeny, and with such high stakes, they will want to guard against throwing their progeny into a purgatory. And third, although the contractors do not know their preferences or what they will consider good and desirable, they do know that there will be some notion of the “good and desirable” that will motivate them, so they seek to secure circumstances that will allow them to pursue this.
We can take Rawls' construction to explore the implications of instability in a capitalist society. Suppose that the contractors are told that whatever system they put forward will be beset by occasional exogenous shocks that destroy wealth. The social and political system may continue through these shocks, but there is nothing they can do to affect the occurrence of the shocks or their result.

Take the two extremes of possible shocks: complete stability versus unrelenting instability. In the first case one's position and wealth are secure. Once you have it, you can't lose it. And if you don't have it, you can't get it. In the other extreme, society is essentially beset with economic revolution, and fortunes are made and lost.

Now back up and suppose that the contractors placed in the Rawlsian veil of ignorance know a little bit more than he allows, in particular, that they know what their initial state will be in terms of position and wealth when the political system is first set, and they also know the degree of instability that will surround that system. What happens when we add this additional knowledge to Rawls' original position?

The greater the instability, the less value there will be in their knowledge of their initial state. In the limit, the additional information of one's initial state means nothing, because everything will become randomized in short order. So we are pretty much back to Rawls' assumption of a veil of ignorance in terms of each person's initial state. Things do not exactly reduce to Rawls' argument, however, because we have an additional piece of information, namely that no matter what system we put in place, it cannot prevent the frequent and arbitrary change in each person's conditions. In this situation, there will be a move toward an egalitarian solution; those who know they will be at the top when the game begins will join those on the bottom rung to vote for an egalitarian system.

Indeed, on an inter-temporal basis an egalitarian system is inevitable in the roll-of-the-dice extreme, in the sense that over the many rolls of the dice sometimes one person will be on the top, sometimes another, and everyone will face the same distribution of wealth. If people are not myopic, that is, if they look at the results of this extreme as it plays out over a long period of time, they will find that the greater the instability – the more frequently the dice are tossed – the lower the dispersion of wealth will be. Indeed, for all practical purposes there will be no private property, because period by period the property will be sold off based on the reshuffling of fortunes. It is “here today, gone tomorrow”.

On the other hand, if there is no instability, and people know their initial states, if everything is set in stone and one's initial state will persist forever, then obviously the rich will vote for a system where the winners keep everything they get, while the losers in the lottery will vote, as they will always, for sharing the wealth.

(Note: We don't need a literal lottery; we can have hard work and talent take a part in getting people where they are, and that each time the world essentially starts over hard work and talent play a part in how wealth gets redistributed. But we need to recognize that luck also plays a role, and so we can still invoke the image of a lottery or a roll of the dice. And, as Rawls asserts, inborn talent comes from the luck of the draw. The joke that someone's best career move was in choosing their parents applies to more than inherited wealth).

Instability and Egalitarianism
This might help provide a context for some of the current debate on wealth, income distribution, and taxes, and the related protests arising throughout the world. Instability helps overcome one of Rawls concerns, and a concern, not always well articulated, that must be in the minds of the protesters and others among the “99 percent”: That the political system, though just, can gradually move toward a result that, ex post, is at variance with the principles that society initially agreed upon.

Rawls concedes that even if everyone acquires their property justly in accordance with the political system and all distributions are done freely in accordance with the agreed concept of justice, it is still possible that over time disparities in wealth may occur that undermine the values from overarching first principle. He states:

Even though the initial state may have been just, and subsequent social conditions may also have been just for some time, the accumulated results of many separate and seemingly fair agreements entered into by individuals and associations are likely over an extended period to undermine the background conditions required for free and fair agreements. Very considerable wealth and property may accumulate in a few hands, and these concentrations are likely to undermine fair equality of opportunity, the fair value of political liberties, and so on.

This gives rise to a possible social contract. Faced with a knowledge of their current state, the people can design a political system that is unstable, thus giving them at shot at the lottery in the future. Or they can move toward one that maintains stability, and in doing so establish the rich more securely. For the people to choose the latter route and participate in a government that entrenches the rich, they will demand an egalitarian structure similar to what they would under the Rawlsian veil of ignorance.

We cannot separate the issues of income distribution from the social system. As a starting point, a wide income distribution requires a developed society. This is somewhat of a tautology, because a distribution suggests a population to distribute, but income distribution is not very meaningful in a family clan. It is hard to be very rich when you are all tilling the land and are all facing risk of starvation. But even more than that, a wide income distribution requires a stable society, which means laws to maintain property rights, a government that is not confiscatory in taxation, and a military that protects the society from attack. It is impossible to discuss the economics without considering the social contract. That is why it is called political economy.

There are many social contracts that are possible. Although we have been focused on the trade off between income inequality and stability, Rawls considers social systems without using the degree of stability as a policy lever, so to speak. A society might decide to have system that is both stable and egalitarian, such as what we see in Scandinavia. The discussion is not one of capitalism versus socialism. We can take unfettered, eat-what-you-kill capitalism as a starting point. The knob that is being turned is the level of social stability. From their perch in my version of the veil of ignorance those who are wealthy in the initial state will choose to construct a society that has less inequality so that the knob can be turned to the “do not disturb” setting.

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