Risk Markets And Politics

Thursday, June 15, 2006

Robert Shiller and the Gordian Knot of for political philosophy

Tyler Cowen asks the possibly rhetorical question, "What is new and essential in political philosophy?" and meets a wall of silence. One commenter aptly notes, "What's astounding is how much distributive justice dominates the political philosophy scene. Justice has become nothing more than the question of how to cut the cake fairly or how to manage emergency room resources in triage." To what extent does political philosophy take justice to be synonymous with minimizing variance in wealth? To what extent is minimizing variance in wealth incompatible with raising average wealth? It is safe to say that insofar as it's possible to do both simultaneously, the solution requires more expertise than that commanded by philosophers "who don't know any actual psychology, economics, or statistics". What then is the contribution of Philosophy? To ask, but not to answer — that's its remaining husk. (Even in countries where philosophy is celebrated, it subsists as a fascinating though impotent Hegelian exercise in web-spinning and knot-tying.)

In The New Financial Order, Robert Shiller adopts a similar principle of distributive justice to that of John Rawls. Specifically, "We will tolerate substantial income inequality. What we surely do not want is gratuitous, random and painful inequality." As with Rawls however, we can still ask to what extent is it possible to remove "random" inequality without lowering average or aggregate wealth. By no means do we wish to lump Shiller (nor Rawls) in with the clueless Left and other futile thinkers, or to imply that he doesn't appreciate these difficulties. Some find the fascination with hedging to be unhealthy and counterproductive, but Shiller is quick to outline cases where risk-sharing encourages productive risk-taking. Nonetheless, the question stands.

Considering Shiller's "macro markets", if GDP has an upwards bias, do we really want to hedge it directly on any significant scale? Hedging is usually done to lock-in an otherwise variable spread that corresponds to some profit margin, which in turn causes wealth to accumulate. Even before transaction fees, hedging directly against a drift will only result in less wealth — unless the situation is quite morbid, in which case the hedge is only treating symptoms.

Shiller's "inequality insurance" is a more obviously Rawlsian idea. Inequality insurance would replace the system of taxation based on tax schedules with one explicitly designed to prevent growth in income inequality. Under this "insurance", the government would determine the total amount of taxes raised and after-tax income inequality (by fixing the Gini coefficient of the Lorenz curve). Again, what becomes of total income? By lowering relative wealth isn't there a significant danger of reducing absolute wealth? Shiller addresses this question and suggests that framing the tax as insurance will mitigate incentive effects at higher income levels. This is doubtful and Shiller doesn't make any strong claims on this point, admitting that incentive effects might very well limit the feasibility of inequality insurance.

Robert Shiller doesn't profess to being a political philosopher, but some of his ideas have a certain resonance with the difference principle, or "maximin". Again, the problem with Philosophers as such is that they ultimately aren't equipped to provide answers. Even if one agrees with them in principle, their lack of technical expertise puts any solutions they venture in peril of spawning undesirable side-effects, or even of having the opposite outcomes from those intended. Unlike economists, philosophers seem particularly vulnerable to neglecting the adjustments that agents will make under new systems. Maybe "reducing variance in wealth" is an incomplete caricature of Left-leaning distributive justice, but even so, the above concerns apply.


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