Inequality, Inefficiency, and Inflation
Economic Concepts on the 2023-2024 Debate Topic
Cara Ewing/Minneapolis Fed
This year’s topic for policy debate is “The United States federal government should substantially increase fiscal redistribution in the United States by: Providing a basic income, adopting a federal jobs guarantee, and/or expanding Social Security.”
The resolution provides a rich base for exploring the costs and benefits of redistribution. This article is an exploration of economic concepts in relation to the debate topic.
Thanks for reading Bolt from the Blue! Subscribe for free to receive new posts and support my work.
This article will focus on affirmative arguments, or arguments in favor of redistribution, as I think the case against redistribution is far simpler and better understood by the community.
Inflation: Background
First, a few definitions of economic jargon:
Scarcity—limited amounts of goods and services. Higher scarcity means that the good or service is more limited.
Inflation—the rate at which price increases of goods and services in the economy. Usually, when referring to inflation, economists are referring to a higher-than normal inflation rate.
The inflation rate increases when the growth of demand accelerates or the growth supply decelerates. Both scenarios mean that supply is becoming more scarce than projected, so self-interested companies will increase prices at a higher rate than before.
Disinflation—when the inflation rate decreases. This is a result of demand decreasing or supply increasing. This is because scarcity has decreased.
Interest Rate—The interest rate is a number set by the Federal Reserve that denotes the appreciation of balances that are held at the Fed. When considering whether to loan funds, banks consider the interest rate as an opportunity cost, or alternative benefit to loaning their money.
Inflation: Applications to Debate
The Inflation Disadvantage
The inflation disadvantage is a negative argument against redistribution. It argues that by accelerating demand growth or decelerating supply growth, the amount of scarcity increases.
Increased Demand
There are many negative arguments for why the affirmative would grow demand:
Money Supply
The amount of money in the economy has increased, meaning that there will be more dollars per person. Naturally, this will result in people valuing their dollars less and spending more.
MPC
The poor have a higher marginal propensity to consume. This means that even without a change in the money supply, there will be inflation. If a low-income person spends 70% of their income, while a high-income person spends 20%, the net increase in demand is 50% of the income redistributed from high-income to low-income households.
Perception
When people think that the inflation rate will increase, price setters (workers in wage negotiations, businesses making decisions setting prices, banks setting the interest rate on loans) will ‘price in’ the amount of inflation by accelerating the rate of price growth over contracts and prices. This can become self-fulfilling, as when contracts price in inflation, this action itself increases the inflation rate by a tiny amount. When done by people across the economy, it can increase the inflation rate wholistically.
To understand this phenomenon, suppose the Fed announces that in 7 days, it will aim to double the money supply, and everyone believes the Fed. There is now an expectation that the dollar will lose half its value. At pre-announcement prices, almost anything is a bargain. If $10 buys 2 slices of pizza, $20 will next week! Conversely, businesses cannot be profitable at the current price. If it costs $8 to make 2 slices of pizza, it will cost $16 in a week, and so all sales at $10 become unprofitable. As a result, businesses will increase their prices to where they expect inflation to be. If businesses and consumers are totally sure of future inflation, prices will immediately double regardless of whether the Fed fulfills their promise.
Reduced Supply
Labor Costs and Participation
Less people will be willing to work, as their non-wage income has increased substantially. Additionally, the cost of recruiting workers may increase, which increases the costs of operating for businesses, thereby lowering the amount of goods that any given company may produce.
Risk Removal
One affirmative argument for a basic income is that it would enable people to take financial risks, as if they fail, they will not be crushed by poverty. Thus, the marginal risks that people would be willing to take will be higher, encouraging potential spending. The negative argues this is a bad thing: the increase in entrepreneurship would be from people who were previously unqualified, which would broaden the pool of applicants for business loans too much.
When the risk of failing is ‘removed,’ unprofitable businesses will be ran for longer, which may steal workers from genuinely productive businesses. Additionally, the higher rate of failure for these unqualified entrepreneurs would increase the amount of defaults and instability in the banking sector. With increased risk, comes a higher interest rate on broad business loans, further slowing productive business growth.
Most other negative arguments are in some sort genre of one of the arguments above. For example, the wage-price spiral argument is the perception argument applied to businesses when negotiating wages and prices.
Affirmative Answers: Inefficiency
Because of the nature of inflation, affirmative arguments must be about increasing supply growth or decreasing demand growth. On this topic, the latter is unworkable, as the federal jobs guarantee and basic income are both massive transfers of money.
There is only one link turn, or reason why the affirmative would reduce inflation is that it would increase supply. It is basically a given that the affirmative increases demand in both the federal jobs guarantee and basic income affirmatives.
Most of the arguments are based off of inefficiency, or a suboptimal allocation of resources that unnecessarily reduces productivity. Inefficiency reduces the real growth rate, or growth of the total production of inflation-adjusted goods and services.
Here are a few arguments for why the economy would be inefficient that the affirmative claims to solve through redistribution:
Income Inequality
Income inequality is a disparity in the amount of money earned across the population. Income inequality can cause a shortage of demand. In one extreme example, suppose that economy A only produces widgets and that 99% of value produced goes to the company. This means that for every $1.00 of widget sales, there is 1 cent of wages distributed among the workers who produce and sell widgets. At this level of income inequality, only 1% of widgets can be consumed absent using non-wage incomes. This distribution of wages is inefficient, as economy A has a massive surplus of widgets, and must scale down production or increase the wages of workers. While in this scenario, the widget company can just increase wages to supplment demand, this power disappears when there are multiple companies in the economy, and the wages paid from one individual company are a tiny fraction of total demand.
For any modern economy, the latter is the case, and businesses are powerless absent a collective action. Shortages in demand can be extremely harmful to an economy. When businesses don’t perceive that there will be enough demand for their products in the future, or that it will go down in the near-future from an economic downturn or other shock, they will scale back production. This action of scaling back production is itself bad for the economy, as it decreases the amount of employment, which consequently decreases wages and demand. Thus, negative demand expectations have become a self-fulfilling supply constraint and propogates artificial shortages.
Debt
Two common solutions to income inequality are welfare and debt. While America isn’t as unequal as economy A, its stagnating wages and increased production has certainly forced a contraction in demand, which can cause catastrophic recessions on the governmental level and an inability to afford necessities at the personal level. To avoid this, the government intervenes through welfare, and individuals intervene by taking out loans. Both mechanisms are unstable and inefficient ways to distribute money, as they are complicated and unpredictable for businesses to deal with.
Financial Risk
The lack of an adequate safety net may prevent would-be entrepreneurs from starting businesses, as they are afraid of poverty if they fail. Larger amounts of welfare can enable more risk-taking in the economy, which will increase production as newer businesses can challenge conventional industry practices and find more efficient or desirable products than established companies.
Misconceptions
“If a Policy is Inflationary, it Harms the Economy”
Inflation is merely an indicator of demand relative to supply. While there are some adjustment costs to inflation, the aggregate effect of inflation is relatively small in comparison to growth. This is because the largest negative effect of inflation is psychological. It comes from having more uncertainty in the value of the dollar, which damages the volatility of contracts. This empirically has had little effect on economic output. If the physical amount of things that we could produce has increased, this will usually overdetermine the negative effect of inflation.
Interest Rates are Key to the Economy
The other impact to inflation is interest rates. While cited as an extremely important economic cost, in context of many redistributive policies may not be so important. The reason why interest rates are bad for the economy is that they reduce demand, which proposals for redistribution remedy. Specifically, higher interest rates target businesses and individuals in debt, as both will have to pay higher rates on their loans. This has been known to disincentivize the starting of businesses or growth, although this effect has been overdetermined by real GDP growth in the past.
Inflation Negates Gains in Supply
One popular negative argument is that the increase in the inflation rate will prevent the poor from gaining purchasing power. This is true only if the affirmative decelerates supply growth. If the affirmative accelerates both demand and supply growth, the poor will very likely benefit. While there will be inflation, it is a result of poor people purchasing more goods in the given market, as that is the source of increased demand from redistribution.
Suppose economy B produces 100 widgets and that there is an equilibrium at $1.00 per widget, with producers able to make 100 widgets at a price of 90 cents per widget. Post redistribution, economy B may produce 110 widgets at a price of 90 cents. In this scenario, it is impossible for suppliers to inflate the price of goods to a point where less people will be able to afford widgets. While the price of the good increases, the amount of producers willing to make the good will also increase, which will consequently increase the amount of people getting the good. The new equilibrium price and quantity of goods exchaged cannot be at a point where less than 100 widgets are purchased, because at any price where it is, producers are both willing and able to make more, and will sell at lower-than-market price.
Remember that inflation is a result of shortages. In a competitive market, the price will increase in a good only if there is too little supply compared to demand. At $1.00, there might be a 10% bottleneck. Therefore, the price must increase to clear 10% of the buyers of this good. While many of the people who decrease their widget demand will be lower-income, some actors decreasing their demand of widgets could be businesses or higher-income households. In the end, the amount of goods we may produce, has increased. The amount of higher-income actors demanding widgets has decreased. It’s a mathematical reality that lower-income households will be able to afford more widgets.
Hyperinflation and Perception
One of the most convincing and competitively successful arguments for hyperinflation is perception. This is because it can often be phrased as an unlimited, as the potential for expectations of higher prices is potentially infinite. However, there are a few natural limits to perception that make it relatively unrealistic.
Money Supply: Because there is a limited amount of money in the economy, the price of goods cannot rise above a given percentage of consumer income. If rent is 200% of consumer income, then it will be unaffordable and the price must be reduced. This is further limited by budgets for each individual good: someone may only spend 10% of their income on groceries, 5% on gas, etc.
The cost of production can only inflate until some producers stop paying, as they deem their production to no longer be profitable. Every bout of hyperinflation has removed this contraint by printing more money, while most affirmatives on this topic are funded by taxation. While this does not deny the inflationary effect entirely, it does remove the possibility of hyperinflation, as it means that there is a soft bound.
Adaptation in Production: When the price of a oil increases by double the average inflation over a year, the suppliers of this good will have more leverage in the market. As a result, the market has allocated it a higher portion of commodities to use for production. Suppose there is a fixed pool of production inputs, and a fixed pool of producer revenue that is denoted by a percentage of demander revenue. That means that the percentage of demander revenue allocated towards the supplier of oil will rise, while the percentage of demander revenue of other producers will fall if the price of their good does not inflate by as much. This can happen for many reasons, but the main one is bottlenecks in production. For example, Ebooks have no bottlenecks in production. If there is an increase in demand for Ebooks, there will be no shortage. In contrast, increases in oil demand must be met with finding new sites to drill, purchasing initial capital, hiring workers, etc. which all are very costly and long-term. Therefore, the price of oil may be far more sensistive to increases in demand than other goods. The suppliers of oil may now hire more workers than the suppliers of Ebooks, which will consequently give it more power to find more efficient methods to produce oil to correct the bottleneck in oil. This will cause the price to self-correct to some extent.
Adaptation in Demand: When the price of a good increases, consumers will find substitutes or use goods more efficiently. For example, when the price of gas increases, the demand for electric cars increases, while other consumers may carpool, buy more efficient cars, or use public transportation more.