We are taught since grade school that society rewards some people more than others, because their work is harder or more valuable. A doctor earns more than a dishwasher, because doctors save lives. Plus, anybody can wash dishes, but it take years of study to become a doctor. This oxymoronic notion – that economic inequality is fair – becomes so ingrained that few people really question it. In fact, we are taught that people who advocate economic equality are evil and dangerous. We call them communists and more lately socialists.
But does this really explain why doctors earn more than dishwashers? Most plastic surgeons don’t save lives or even heal their patients. And what explains why some doctors earn more than others? The average family practitioner does a lot more good for society as a whole than a Park Avenue surgeon specializing in nose jobs and tummy tucks, but earns a fraction of what the surgeon makes.
In truth, a whole array of complex economic factors, more than societal values, determine what people earn. When we say that complex economic factors determine what people earn, we are really saying that the economic system values certain types of skills more than others. I suspect the “value to society” explanation is a rationalization, an after the fact socially acceptable explanation for something that is otherwise hard to justify. Why does this matter? It matters because the economy is shaped by laws. In a democracy, the legislators theoretically enact laws that benefit their constituents, but in order for this to work properly, the constituents must understand how laws affect their lives.
To illustrate the point, let’s imagine that society valued one’s contribution according to how skilled a chess player he or she was. Most people do not play chess, or play it poorly. I would estimate that about ten percent of the population can play a game without making a complete mess of things, and about one percent play it moderately well. Exceptional players are a tiny percent of the population. In other words, if wealth were distributed according to the ability to play chess, it would pretty much resemble the way wealth is currently distributed.
Distributing wealth according to how well one plays chess, however, is a really bad idea. While I like chess and think it’s a great exercise for the mind, there is absolutely no reason why somebody’s economic circumstances should depend on the game. That’s completely arbitrary, or, as younger people are fond of saying these days, totally “random.” But it is not that much different from the exaggerated value we currently put on financial skills. Finance is a lot like a game of chess. Finance doesn’t make anything or provide any necessary service. It largely consists of rearranging pools of money and taking a cut in the process. Not that much different from moving chess pieces on a board. At the end of the day, however, in chess and in finance, you end up with pretty much what you started with.
So why are financial skills valued so much? Pretty much because, over the past 35 years or so, there has been a steady changing of laws so that what people do with money is rewarded more than what people do with their hands (as in manufacturing) or their time (as in services, except financial “services.”)
Let’s take credit cards as an example. Time was most states had laws which set a max on the amount of interest a credit card company could charge, usually in the range of 9 to 12 percent. Then the Supreme Court decided that a bank could charge whatever interest rate was legal in the state where the “lending decision” was made. This changed the law, and as a result all the major banks sought out states that removed the limit on credit card interest rates. Did you ever notice that your credit cards are all issued out of South Dakota or Delaware? That’s because those states have very loose laws, or no laws at all, concerning credit cards.
These two changes in the law – first the Supreme Court decision and then the laws passed by several states to remove limits on credit card interest rates – have resulted in a huge flow of new money from consumers to the banks. How much money? There are more than 150 million credit card holders in the United States, and the average interest rate for all credit cards is around 14 percent. That means that a significant percentage of credit card holders pay more than 14 percent. If 50 million credit card holders pay 20 percent on an average balance of $5,000, that is 250 billion in debt. The different between 20 percent and 12 percent (which was a common interest rate cap before the changes in the laws) is 8 percent, and 8 percent of 250 billion is a tidy 20 billion a year in additional interest.
Many people are extremely ignorant in the field of finance. They tend to do poorly with credit cards. Not that it’s easy to decipher the average credit card disclosure statement, in fact, they are completely unintelligible as a rule. But it’s all legal, and they are all designed to maximize profits for the financial institutions at the expense of the customer. Is this fair? Should it be legal? The argument of the credit card companies is that credit cards provide relatively easy credit for consumers enabling them to make purchases that would otherwise be out of their reach. There is always somebody talking about “personal responsibility” and “freedom” and that it’s not the government’s job to protect people against their own bad decisions. (Unless of course it’s the giant banks that are “too big to fail” that make the bad decisions, in which case it’s a matter of national urgency.)
These arguments really miss the point. The point is that we reward people who are more adept at understanding finance and we punish those who are less. Financial skills, however, have no particular merit in and of themselves, and there is no reason we need to structure our economy to create this division of winners and losers. It makes no more sense than distributing wealth according to one’s chess skills.