Lecture 17: The Politics of Comparative Capitalism (1)

Introduction 

Why are some countries more unequal than others? This is a question that is central to the study of comparative political economy.

Interests, ideas and institutions interact in different ways to produce cross-country variation in public policy outcomes (varieties of capitalism) between countries.

  • Interests
    • Producer groups; business-state interests; electoral coalitions
  • Institutions
    • Rules of the game that shape actor behaviour; path dependency
  • Ideas
    • Belief systems; cognitive shortcuts; instruction sheets; ideologies

The supply and demand of politics

More specifically, to explain cross-national variation in public policy outcomes (varieties of capitalism), consider the “supply” and “demand” of politics.

  • Demand = what voters want (attitudes/preferences)
  • Supply = what political parties have to offer (party strategies).

To understand how these have changed (particularly the demand side of politics), we need to look at the socio-structural change in the labour market.

    • This has led to new socio-economic and new socio-cultural cleavages

Globalisation and labour market change 

Most research would suggest that the main long-term driver of labour market change is technology, which transforms the jobs we do.

This is often just referred to as “globalisation”.

In advanced capitalist societies, there are four distinct trends:

  • A growth in service sector jobs
  • Occupational upgrading
  • Increased job polarisation
  • Increased female participation rates in the labour force

All four have important socio-political consequences (demand side of politics).

The political economy of the service transition

In most advanced capitalist societies, services now constitute 75% of employment. Industry and agriculture makes up the rest.

  • High-skilled services in the competitive/traded sector (finance/ICT)
  • High-skilled services in the public/non-traded sector (education/healthcare)
  • Low-skilled services in the exposed sector (retail/security/leisure/food/care)
  • Low-skilled services in the non-exposed sector (transport)

The extent to which each of these groups are threatened by globalisation (free movement of goods, people, services) impacts their electoral preferences.

Occupational upgrading and job polarisation 

Job polarisation is often described as the “winners/losers” of globalisation.

  • The “winners” are those in high-skilled, high-income, business-finance jobs (legal/consultancy/accountancy/managerial), and high-skilled socio-cultural professions (education/healthcare/civil society).
  • The “losers” are those in low to medium-skill, median-income jobs such as administrative-clerical workers, and industrial operatives (manufacturing).

Job polarisation refers to the extent to which there is a growth in high-skill jobs and low-skilled jobs, and a hollowing out of median-skilled jobs.

Feminisation of the workforce

Perhaps the most important socio-structural change in the labour market over the past generation (30 years) is the increase in the number of women working.

This is what’s called the female “participation rate”.

  • In most northern European economies, with universal childcare, this is usually 70+%. In southern European economies, it is as low as 50%.
    • But these numbers vary significantly when women reach 35+.
  • In Ireland, the number is also low, and varies between 58-60%.

It’s also worth noting that most people who work low-paid precarious jobs (sometimes called “pink” jobs) in the domestic service sector are women.

Conclusion

Why does this matter?

See: https://capitalistdemocracy.files.wordpress.com/2018/11/r-voters-1-cultureeconomy.pdf

Next week, we will conclude our lecture series by examining how these socio-structural changes are impacting the socio-economic and socio-cultural preferences of voters.

Lecture 17

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Lecture 16: The Fiscal Crisis of the Social State in the 21st Century

Introduction

We have now analyzed the distribution of wealth and income inequalities in Europe since the 18th century. Inequalities of wealth are close to regaining or even surpassing their historic highs of the 19th century.

Keep in mind these two tables, which depict the trends in inequalities of total wealth (ownership of capital) and the inequalities of total income (labour + capital income) in Scandinavia, Western Europe and the USA. Note the magnitudes of difference.

inequality-of-capital-ownershipinequality-of-total-income

This begs the question: What is the role for government in shaping the politics of distribution in the 21st century? How do democratic states resolve the conflict between private capitalist markets and democratic social rights?

Market competition or social rights?

Increasingly, governments have to satisfy two different constituencies: markets and voters. This friction is reflected in two competing principles of resource allocation: markets and social rights. Governments can either tax (citizens, firms and consumers) or borrow (debt financed expenditure) to fund (pay for) public services.

To give an example of the new constraints facing the democratic state, consider the following: In the aftermath of the great depression the US President, Herbert Hoover, raised the top marginal income tax rate to 80 per cent. In the aftermath of the great recession, the Obama administration struggled to increase it beyond 35 per cent.

Now think about the debate on tax reform under Trump. Corporate taxes are to be reduced to 20 percent.

Post-financial crisis 

The global financial crisis revealed the importance of public institutions: Central banks and the welfare state,  in mitigating the worst effects of the financial market. Absent government and central bank intervention, economies would have entirely collapsed.

Effective economic and social policy is not just about the level of income and capital taxation. The capacity to raise tax revenue is a core characteristic of how democracies manage capitalist markets. Weak states struggle to raise revenue and provide services.

The constraints placed on the public finances in the aftermath of the international financial crisis was not an outcome of market imperfection.

For Wolfgang Streeck, it reflects a continuous and ongoing transformation of that fragile post-war creation that we now call democratic capitalism (a relatively recent creation in the long history of capitalist development). Is this coming to an end?

The fiscal state

The role of the state in the advanced economies of the world, has been constantly evolving, particularly since end of World War II.

Contrary to many of the assumptions of “neoliberalism” the state is not in retreat.

The state is just as involved in shaping economic and market outcomes today as it was in the 1970’s. What has changed is the function of the state. Much like the structure of capital, the structure of the state has fundamentally changed over time.

On the one hand, nation-states require new supranational forms of governance to manage global financial markets (think about the European Union), whilst on the other, the domestic welfare state is in constant need of modernisation (changing tax and spend policies to reflect new realities, and social problems).

The simplest way to measure the role of the state in the economy (and society) is to look at the total amount of taxes relative to national income.

Figure 13.1 shows the trajectory for Sweden, France, Britain and the USA.

Prior to WW1, the state had no real role in economic and social life. With taxes equivalent to 7-8 per cent of national income, the state could just about manage those “regal” functions of managing a police force and an army. The state existed to maintain social order and to defend property rights.

Between 1920-1980, the share of national income that rich countries began to devote to social spending grew substantially. It increased by more than a factor of 5 in Nordic countries. But between 1980-2010 the tax share stabilised almost everywhere.

The fiscal revolution, which gave birth to the democratic social state, during the 20th century, is now over. This gives rise to the question: What will the fiscal state look like in 21st Century? Can “nation” states manage the constraints of “global” capital?

The social state

Tax revenue has stabilised at around 30 per cent in the USA, 38 per cent in Ireland, 40 per cent in the UK, 45 per cent in Germany, 50 per cent in France and almost 55 per cent in Sweden.

This growing tax bill has enabled the state to take on broader public service functions, which now consume between a third and a quarter of all government expenditure, depending on the country in question.

One half of this goes on health and education, whilst the other half goes on replacement incomes and transfer payments. Hence, for the most part, the social state is constituted by expenditure in healthcare, education, eldercare and social protection.

Politics is not just about elections. It is about making public policy. Policy regimes vary significantly between countries: neoliberal (USA), social (Scandinavia) and coordinated (Germany) market economies are not the same.

They manage the implicit tension between capitalism and democracy in different ways.

Trying to explain these differences (in terms of public policy outcomes) is a core part of the study “comparative” political economy. See this recent book, the politics of advanced capitalism, which we will discuss next week.

Social rights

Public spending on health and education consumes around 10-15 per cent of national income in most capitalist democracies today.

Primary and secondary education are almost entirely free for everyone in the rich democracies of the world (although some countries, like Ireland, heavily subsidize private education as well).

Public health (either via insurance or direct provision) is universal in most European countries (although some countries, like Ireland, heavily rely on private provision too).

Childcare provision is also universal in most European countries (with some exceptions, such as Ireland).

Replacement income and transfer payments also consume almost 15 percent of national income in European countries (primarily because of high unemployment in the aftermath of the crisis).

In most developed democracies, the government taxes (workers, firms, consumers) and then spends this in terms of income replacement to households that cannot work (pensions, unemployment compensation, family, disability and children’s allowance), or in terms of social investment/services (health, education, research/development, childcare).

This gives rise to an important distinction between social protection, and social investment.

Pensions are the biggest component of “income replacement” in most countries. Think of this as a consumption replacement. But for most countries, services are the biggest expenditure.

Hence, the growth of the “fiscal state” over the last century reflects the constitution of the “social state”. This, in turn, reflects the democratic demand that citizens place on government, and which is usually articulated in terms of social rights: Education, healthcare, pensions (and in some countries, housing).

Modern redistribution

Modern redistribution is not primarily about transferring income from the rich to the poor but financing public services.

It is built around a logic of democratic rights not market competition.

Democratic questions pertaining to social rights will never be answered by abstract principles and mathematical formulas.

The only way to deal with questions of social rights, and what the state should and should not provide, is through democratic deliberation. Further, there are very few examples in history where social rights were won without social conflict and political confrontation.

The political and media institutions that govern democratic debate will, therefore, play a crucial role in shaping the politics and discourse of what constitutes fair distribution.

Ideology clearly plays an important role here. Ideological attitudes toward the “state” are probably most divisive in the USA.

This is not just about comparative differences in electoral and political party rules (majoritarian and proportional systems of representation) but the variation in the relative power resources of interest groups and the persuasive capacity of different social actors to shape the terms of the debate.

See Jacob Hacker & Paul Piersons (2016) book “American Amnesia: How the War on Government Led us to Forget What made America Prosper“.

Conclusion

The revolution in the public financing of the social state is not likely to be reversed in any rich democratic country. That is, it’s hard to imagine a political party winning a democratic election, and forming a government, on a platform to end public provision of health, education, eldercare, childcare and social protection.

There are certainly huge constraints on expenditure and taxation, particularly as it pertains to pensions, but no country is likely to cut social spending back to less than 20 percent of national income. This would require ending public service provision, and ending public sector employment.

On the contrary, there is huge fiscal pressure on the state to expand and to invest in new forms of social investment such as higher education, research/development, public transport, affordable housing, vocational training, water, childcare, sustainable energy,  digital communications, broadband and a whole host of other infrastructural investments.

This political and societal pressure to expand and invest, however, confronts the financial market pressure to consolidate public finances, and reduce expenditure i.e. austerity. Governments everywhere are trying to reduce their public debt burdens through cuts to expenditure and tax increases.

The implication is that the capacity of the state to engage in new forms of discretionary expenditure/investment is in decline.

Furthermore, the expansion of the state during the past 50 years was dependent upon one crucial condition that cannot be guaranteed: strong economic and productivity growth. Absent strong economic growth, governments, by definition, cannot raise revenue, as tax expenditures fall. Growth has slowed down almost everywhere.

Hence, for many the crisis of economic growth is the crisis of advanced capitalism, as it makes it increasingly difficult for governments to commit to continue to pay for what citizens expect as a social right. Future debates about the fiscal state are likely to revolve around issues of economic growth, structural reform, public sector modernisation and the consolidation of social spending.

It is in this context that the ability of large MNCs to avoid paying tax, through exploiting cross-national tax competition laws, has become politicised. In the EU, the ability of nation-states within the same Union to use corporate tax laws to attract module capital, is perceived as leading to a race to the bottom.

Discussion

The demand to reform the social state and improve the quality of public services is a very legitimate concern. Taxpayers tend to support public financing when they receive better quality services, and when they have higher levels of trust in government.

To tease out this fiscal crisis of the state discuss the following questions:

  • Should access to higher education be free?
  • Does it make a difference that it does not impact upon social mobility?
  • What about the right to retirement, does everyone have a right to a pension?
  • Who should pay for all this?
    • That is, who should pay the tax to fund these services/investment?

Lecture slides: lecture-16

Lecture 15: The future of global wealth inequality

Introduction

Should democratic societies be concerned about wealth concentration?

In market democracies, the assumed equality of rights of all citizens contrasts sharply with the real inequality of living conditions among people.

The normative justification of this inequality rests upon the assumption of merit and hard work.

Figure 11.11 illustrates why Piketty is concerned about inheritance.

This has a tendency to undermine merit. In 1893, Durkheim assumed that liberal democracies would abolish inheritance and property at death.

screen-shot-2016-11-09-at-12-36-46-p-m

Inheritance 

The graph shows that for those born around 1970-1980, 12-15 percent of individuals will inherit the equivalent of what the bottom 50 percent of the population earn in a lifetime.

Piketty suggests that inheritance and rent seeking are problematic in a democracy but inevitable in a market economy. Why? Because in a context of R>G, inheritance will predominate over savings, and earned income.

When Mario Draghi took over as president of the European Central Bank (ECB) his proposal to resolve the Euro crisis was to “fight against rents” in Europe. What he meant by this was the fight against monopolies.

For economists, the term ‘rent’ is usually pejorative as it is assumed to equal the lack of competition in a market, particularly in the non-traded services sector.

But historically ‘rent’ was a term that was used to describe any income that was earned from owning a capital asset. It is unearned income.

What is Piketty getting at here? 

For Piketty ‘rent and inheritance’ are not an imperfection in the market. Rather they are the logical consequence of capital accumulation.

He is highlighting that market and economic rationality have nothing to do with democratic rationality. Democracy and social justice require specific institutions of their own, and these cannot be justified in terms of market competition.

When universal suffrage was instituted in the 19th century (and property voting abolished) it ended the legal domination of politics by the wealthy.

But it did not abolish the economic forces capable of producing a society of rentiers.

Global inequality 

Let’s move on to examine why this matters at a global level.

Financial globalisation and the inequality of R>G leads to a greater concentration of wealth ownership. This automatically contributes to a structural divergence in the ownership of wealth, particularly at the very top of the income distribution.

One way to observe this (the impact of the R>G inequality among the top centile) is to examine global wealth rankings (ranking of billionaires) and global wealth reports.

Both of these rankings illustrate that the rate of return on the largest fortunes has grown significantly faster than average wealth. See the latest Crédit Suisse report here.

It suggests that there are two worlds at the top.

Global wealth

Global inequality of wealth in the early 2010’s is comparable in magnitude to that observed in Europe in 1900-1910.

The top 0.1 percent own 20 percent of global wealth, the top 1 percent own 50 percent of global wealth and the top 10 percent own between 80-90 percent of wealth.

If the top 0.1 percent (4.5 million people) enjoy a 6 percent return on their wealth, whilst average global wealth grows at 2 percent a year, then after 30 years, their share of global capital will increase to 60 percent.

Is this compatible with democracy?

Global tax

Piketty suggests that this type of market regime is not compatible with democracy, and therefore it requires some sort of political intervention.

Hence, his proposal for a global wealth tax.

Other mechanisms to redistribute include: inflation, expropriation, nationalisation.

The unequal returns to different types of capital assets (which is heavily dependent upon the initial portfolio size), and the fact that the highest fortunes grow significantly faster than average wealth, amplifies the inequality R>G.

All large fortunes, whether inherited or entrepreneurial in origin, tend to grow at extremely high rates.

Once a fortune is established, the capital grows according to a dynamic of its own.

Money reproduces itself.

But more importantly, inherited wealth accounts for more than half the total amount of the largest fortunes worldwide.

Hence, the entrepreneurial argument does not justify all inequalities of wealth. Fortunes can grow far beyond any rational justification in terms of social utility. This is Piketty’s justification for a progressive annual tax on capital-wealth.

To quote him directly:

Every fortune is partially justified yet potential excessive. Outright theft is rare, as is absolute merit. The advantage of a progressive tax on capital is that it exposes large fortunes to democratic control.

University endowments 

Another way to observe whether greater the endowment/size of capital, the greater the return, is to examine the capital endowment of US universities.

Table 12.2 reports the findings.

The average real rate of return for Ivy League US Universities was 8.2%. The higher rate of return is an outcome of very sophisticated investment strategies.

Most of these top universities invest in high yield assets such as private equity funds, foreign stocks, derivatives, real estate, natural resources and raw materials.

They tend not to invest in US government bonds.

These large returns on capital endowments largely account for the prosperity of the most prestigious US universities.

Should the US government tax these institutions higher and redistribute to poorer colleges? Or should they let billionaires build their own universities?

Sovereign wealth funds 

Consider now the case of sovereign wealth funds and petroleum states. Unlike US universities we don’t know what the investment strategies of these funds are.

The Norwegian sovereign wealth fund is worth about 700 billion. 60 percent of money earned from Norwegian oil is reinvested into the fund, while 40 percent goes to government public services and expenses.

The financial reports of the next two biggest sovereign wealth funds: Abu Dhabi Investment Authority and Saudi Arabia, are more opaque.

Abu Dhabi boasts an average return of 7 percent, whilst Saudi Arabia is approximately 2-3 percent. This is because Saudi Arabia primarily invests in US Treasury bonds.

At a global level, sovereign wealth funds hold total investments that equal $5.3 trillion, of which $3.2 trillion belongs to petroleum exporting states.

This is the same as the fortune of all the worlds billionaires.

Petro states

As oil becomes more scare and its price increases, the inequality R>G would imply that the share of global capital going to petro-states could reach 10-20 percent.

This would not bode well for democracy, as it implies growing economic dependence on oil-producing states.

Their populations are often tiny but their investments are huge.

Can we imagine a democracy blocking sovereign wealth funds from buying up real estate or other assets in a country?

China

A large portion of the global capital stock is accumulating in Asia, particularly China.

In borderless capital-markets, inward Chinese investment is causing some political tension. See figure 12.5.

The big difference between China and the small Arab oil-producing monarchies is that Asian populations are huge. Most of their future investment is likely to be spent on their own domestic populations.

The total real estate and financial assets, net of debt, owned by European households is 70 trillion whereas the sovereign wealth fund in China is less than 3 trillion.

Rich countries are being taken over by domestic oligarchs not China.

Conclusion

Wealth in most western democratic countries is private and cannot be mobilised by governments for public purposes.

For example, during the euro crisis, the Chinese recommended to the EU to mobilise private capital within its borders to solve the Greek debt crisis.

But the EU cannot regulate, tax or mobilise the capital and income it generates within it’s member-states. Small states are competing with each other to reduce capital taxation at the very moment when demand for public expenditure is increasing.

Cautious estimates suggest that unreported financial assets held in tax havens amount to nearly 10 percent of global GDP. Most of this belongs to residents of rich countries.

To overcome these contradictions Piketty proposes a global tax on capital wealth, particularly within the European Union.

Is this feasible?

Discussion 

Is Piketty (among many other scholars) right to be concerned that domestic wealthy oligarchs are in a position to distort democracy?

The slides:lecture-15

https://edition.cnn.com/election/2018/exit-polls

 

Lecture 14: Wealth Inequality in Europe and the USA, 1810-2010.

Introduction 

In this lecture we are returning to the question of wealth inequality.

This is the inequality that arises from the ownership of capital. In 2016, global wealth was estimated estimated to be $262 trillion.

Almost 50% of this is owned by 1% of the world’s population.

In lecture 12, we concluded that the only reason why income inequality declined in the 20th century was because the income arising from capital ownership declined.

This implies that the overall fall in income inequality in Europe, during the 20th century, was almost entirely explained by the fall in capital-income.

It is therefore essential that we understand how this compression in the inequality of wealth came about, and why it is rising again.

Revision

Table 7.2 shows that in all known societies the poorest half of the population own nothing (generally 5% of wealth).

The world of 2016 is no different to the world of the 19th century in this sense.

capital-ownership

The top decile have generally owned between 60-90% of wealth.

The middle classes have generally owned between 5-35%. The emergence of a property owning middle class transformed wealth distribution in the 20th century.

Let’s take a look at these empirical trends in Europe and the USA overtime.

France 

Figure 10.1 depicts trends in wealth inequalities in France from 1810-2010.

What we observe is that the top decile owned between 80-90% of wealth from 1810-1910, which has declined to about 60-65% today.

This longitudinal data is available because of the introduction of an estate tax in 1791 on all forms of wealth: property, assets, bonds, savings, land.

Looking at these trends in capital ownership, it is interesting to ask what would have happened had there been no war? The shocks of the two world wars disrupted the dynamics of wealth distribution because it ushered in the era of capital taxes.

Inequality of capital ownership remained stable at an extremely high level throughout the 18th and 19th century. The top decile owned 80-90% whereas the top centile owned 50-60%. The French revolution had very little impact on this.

France was a patrimonial society, characterised by a hyper-concentration of wealth. This was generally the case throughout Europe.

When the top decile’s share of wealth in the 20th century declined, it went exclusively to the middle 40 percent of the population. The poorest 50 percent owned nothing in the 19th and 21st century. This has not changed.

Britain and Sweden 

Figure 10.3 and 10.4 show that the same extreme concentration of capital ownership and wealth existed in Britain and Sweden. Germany was also very similar.

In Britain, the top decile owned 80-90 percent of total wealth in 1910, which has declined to about 70 percent today.

In 1910, Sweden was just as unequal. It was nothing like the egalitarian country it became during the 1970’s.

The essential difference today is that there is a home owning middle class, who own about one third of national wealth, and most of which is bound up in housing capital.

Much like in France, the wealthiest 10 percent lost to the middle 40 percent during the period of strong growth in the 20th century (the period of democratic capitalism).

Nothing went to the poorest half of the population.

USA

Figure 10.5 shows that in the USA the top 10 percent owned 80% of total wealth in 1910, and which has remained more stable, and equates to about 75 percent today.

We are accustomed to the fact that the US is more unequal that Europe, and that public opinion in the US is more tolerant of inequalities. But this was not always the case. A century ago, the US prided itself on the fact that it was more egalitarian than Europe.

From 1910-1930, the US pioneered a progressive income and wealth tax to limit growing inequalities. In the early 20th century, high levels of inequality were deemed incompatible with the democratic values of the free-world.

Hence, perceptions and attitudes toward inequality and redistribution have changed a great deal over the 20th century. Why? Does the media have a role to play?

Europe/USA

Figure 10.6 compares capital ownership and wealth inequality in Europe and the USA.

The decline in Europe during the 20th century created a perception that capital had been tamed, and that the role of the state was to guarantee social rights, and that inherited wealth mattered less than hard work and merit.

Keep in mind the history, post WW1, there was an assumption economic inequalities created a sharply divided class society, and that this was to be relegated to the past.

The Mechanism of Divergence: R>G

What explains the hyper-concentration of wealth and capital up until WW1, it’s subsequent decline, and it’s rise again?

For Piketty, the fundamental macro-social driving force is the inequality R>G.

These were low-growth societies (G), where rate of return on capital (R) was markedly higher than economic growth. Capital income outstripped labour income.

If G=1% and R=5% then fortunes grow faster than the economy. Capital accumulates and concentrates. This is an ideal condition for an ‘inheritance society’.

Most wealth during the 18th and 19th century came from inheritance. This is what Piketty calls ‘Patrimonial Capitalism’. He also think this is the future of the 21st century.

Why?

It is important to note that the inequality R>G is a historical-empirical observation and not a logical necessity. It can always be otherwise. Figure 10.9 illustrates the point.

The rate of return on capital (pre-tax) has always been higher than the world growth rate.

Throughout human history the rate of return on capital has generally been 10-20 times greater than economic growth (and income). The gap narrowed in the 20th century because of politics, and those public policies that were explicitly aimed at reducing class inequalities. Absent political and fiscal intervention, it will rise again.

Global growth is set to slowdown, as successive IMF reports suggest. This correlates with a rapid rise in wealth inequality, documented in this recent Oxfam report.

In a context of slow growth, high-capital returns and rising wealth inequalities, it is easy to see why Piketty proposes new taxes on wealth/capital to reduce the R-G inequality.

The argument against this fiscal policy proposal is that increasing taxes on wealth and capital discourages economic and income growth/investment. But does it?

Taxes and growth

Before WW1 taxes on capital, profits and property were very low. This changed after WW1.

Since 1980, and with heightened international competition for capital investment, they have become very low again.

Piketty hypothesises that the logical end goal of corporate tax competition between nation-states is a 0% capital tax regime.

Figure 10.10 and figure 10.11 hypothesise what will happen if taxes on capital continue to decrease  (intensified capital tax competition) into the 21st century. R>G will return.

What the data suggests is that the after-tax return to capital fell from 1913-1950 (higher capital taxes) and continued to decline from 1950-2010 (stronger economic growth).

During the 20th century, and for the first time in history, the net return on capital was less than the income-growth rate. It was better to work that rely on inheritance.

The social state

This was the period during which the social (welfare) state, committed to providing certain public services and income protection, as a social right, was born.

Democracy gave birth to “social’ rights” not market competition.

The social state is now under increasing strain because of growing international market constraints to both increase public expenditure and cut taxes.

This is often described as the crisis of fiscal democracy i.e. who is going to pick up the bill to pay for democratically enshrined social rights and electorally demanding services?

The role of politics 

Figures 10.10 and 10.11 rely on the assumption that there will be no political intervention to alter the trajectory of financial globalisation over the coming century.

But is this plausible? Will democracies accept rising wealth-income inequalities?

The R>G inequality is a logical outcome of free and competitive capital markets, but it is also institutionally embedded and shaped by public policies, politics and institutions.

To reverse the R>G inequality, economic growth would need to exceed 2 percent over the coming decades and/or taxes on capital would need to reduce the net return to below 3 percent. Absent this, capital/income ratios will continue to grow.

There is no equilibrium distribution of wealth. Left to its own devises, the market will ensure that the inequality in capital ownership and wealth will grow indefinitely.

The freer the capital-market, the greater the inequality of wealth.

Impact of war

We still need to explain why wealth inequalities have not returned to 19th century levels?

One of the most important reasons was that WW1 and WW2 brought an end to inheritance.

A new generation did not have the luxury of inheriting fortunes that would enable them to live as their grandparents had, which in some cases was +100 times the average.

  • The rich/elite lost a lot of their capital assets (not least in their foreign colonies).
  • Governments defaulted on the sovereign debt owned to wealthy individuals.
  • Industrial firms were closed or nationalised.

This meant that those at very top of the wealth distribution were disproportionately effected by the shocks of the war, and the subsequent public policies that were instituted.

Taxation 

Total private wealth, measured in capital/income ratios, has now regained the level it attained on the eve of WW1.

The reason why it is has not become as unequally distributed is because governments now tax capital (and capital income) at significant rates.

Up until WW1 there was no tax on corporate profits.

If capital grows at 5% and the average capital tax rate is 30% then the net after tax return to capital will be around 3.5%.

Taxes on capital do not modify the accumulation of wealth. Rather they affect the distribution of wealth. Think about the case of Apple.

Did Ireland’s fiscal policy impact on Apple technology and production? No. But it did impact how their profits were distributed.

Conclusion

Wealth inequalities grew throughout the 18th-19th century because of the inequality R>G. The birth of the democratic state put an end to this.

The 18th-19th century was a period of ‘patrimonial capitalism’. In the 20th century, Europe and the USA instituted a new regime of democratic capitalism. Many suggest that this regime came to an end with financial globalisation, from the 1980’s onwards.

Wealth inequalities declined in the 20th century because of the shocks war and the creation the social state, in addition to the emergence of a property owning middle class.

Piketty suggests wealth inequality will increase to 19th century levels again because of:

  • The return of the inequality R>G (slower growth)
  • Increased tax competition among nation-states in a global financial market.

On this basis, it should be obvious why Piketty proposes a global wealth tax. He considers this the only option to defend democracy against wealth inequalities.

Question/discussion: is the R>G inequality plausible as an explanation for wealth inequalities? How does he measure the rate of return on capital?

Does IT adequately address the comparative differences we observe between countries?

Class discussion: do societies trust the state to raise new taxes and deliver services?

Slides: Lecture 14

Lecture 13: Explaining the Rise in Income Inequality

Introduction

Screen Shot 2018-10-22 at 15.48.43

Last week we discussed the rise in income inequality in the USA and its relationship to the global financial crisis. We noted that the rise in income inequality has occurred everywhere, but it is particularly pronounced in the USA and the UK. We also noted that this is directly associated with the rise in the incomes of the top 1 percent.

But what caused this rapid rise in income inequality, when measured as the rise in incomes of the top 1%, and stagnation of working/middle income wages?

Most economic explanations tend to emphasise a-political processes of economic change: education, skills and technology. This is usually captured under the term “skills based technological change”.

These certainly matter in the long run. Most research would suggest that education and technology are perhaps the most important long term drivers of productivity improvements.

But most economic accounts of technological change cannot explain:

  1. The extreme concentration of income gains at the very top of the economic ladder.
  2. The role of public policy in creating a winner takes-all pattern.
  3. The change in the collective and organisational landscape of politics.

Winner takes all politics

The concept of “winner-takes-all politics” is a critique of the conception of democratic politics that emphasises the “median voter”. This perspective emphasises the role of “organized interests” in shaping electoral politics and the process of policymaking.

Jacob Hacker and Paul Pierson (2010) have long argued that political economists are wedded to a conception of public policy that assumes the electorate shape economic policy outcomes. From their perspective, economic policy is predominantly shaped by corporate-business elites (i.e. business interests outside the electoral process).

They start with the question: If electorates determine economic policy, then why don’t the poor soak the rich (given that most people earn below the median wage)?

They argue that to explain the phenomenon of rising economic inequality in the USA we need to analyse policymaking as “organised combat” between organised interests.

For Hacker & Pierson, the winner takes-all dynamic (i.e. where most income gains go to the top 1%) is rooted in how four different institutions shape public policy outcomes:

  • Financial markets
  • Corporate governance
  • Workplace relations
  • Taxation

I will return to these later. But before we discuss these policy spheres, we need to understand why countries differ in terms of their national models of capitalism.

National models of capitalism 

Piketty also acknowledges the important role of political and economic institutions (chapter 9) in shaping the cross-national variation in patterns of income inequality.  But in the end, he gives priority to different ideas of fair compensation.

It is important to note that the explosion in wage inequalities is predominately an Anglo-Saxon phenomenon. In particular, it is a UK and US phenomenon. Why?

Figures 9.2, 9.3 and 9.4 show the share of the top percentile in Anglo-Saxon, Continental and Northern European countries. Note the variations.

This family resemblance in different countries should not obscure important differences between countries. But there is a clear clustering effect. English speaking countries are significantly more unequal than their continental and Scandinavian neighbours.

There are 3 important characteristics of the Anglo-Saxon dynamic of inequality:

  1. Gains have been highly concentrated. The top percentile in the US have seen their share of national income rise from 9 to 23.5 percent.
  2. Gains have been sustained, regardless of the partisan nature of government.
    • Figure 1 in Hacker & Pierson (2010) shows that this concentration began with Ronald Reagan and continued under every subsequent administration, regardless of whether it was a Democrat or Republican president.
  3. Gains have not resulted in a trickle down effect. Wages at the bottom and middle have stagnated for a long period of time.

Between 1979 and 2005 the average incomes of the poorest fifth of US households increased by 6%. The middle classes saw their incomes rise by 21%, whilst the after-tax income of the top 1 percent rose by 230%.

 Can different levels of education and skill  explain this outcome?

The macroeconomist, Gregory Mankiw, argues that the “golden ticket” of elite education is what grants grants access to the 1%, and that this is a meritocratic process, driven by market competition. But is it? Is it not more related to politics and social class?

Compatibility with democracy

Is this extreme rise in economic inequality compatible with democracy?

In most political economy models, median voter theories would suggest that the majority of the electorate should vote for governments who favour redistribution. This, however, is not the case. People don’t just vote on the basis of economic self-interest.

This is what’s often called the “Robin Hood” paradox.

Median voter models of behavioural science are useful for explaining general trends but they are less capable of explaining the Robin Hood paradox.

But if voters do not run the show, who does?

As mentioned above, answering this question requires going beyond the voter-party relationship, and analyzing politics as a form of “organised combat” between competing interest groups, particularly the “quiet politics” of corporate influence.

This perspective gives priority to the business-politics relationship over electoral politics, and makes three important claims about who actually makes economic policy decisions:

  1. Government involvement in the economy is broad and deep.
    • Governments do not simply redistribute what markets produce. They actively structure markets in ways that shape economic outcomes. The role of the state in the market varies significantly between countries.
  2. The transformation of policy occurs through drift.
    • Policymakers can effect change by not taking decisions. This suggests that policy change does not occur primarily because of entrenched interests and political vetoes in the policymaking process. Lobbying results in non-decisions.
  3. Shifts in the balance of organised interests as the driver of policy change.
    • What governments actually do (make policy/legislation) is a long hard battle between competing organised interests that often takes place outside the media and electoral spotlight.

Politics as a form of organised combat 

Organised interests influence and build coalitions of interest within and between political parties in government. Political parties are anchored in various interest groups, and agents of societal interests.

The implication is that political parties have, arguably, become more responsive to the concerns of economic interest groups, and less the preference of the median voter.

Drift is the cheapest way to abandon the median voter.

But ask yourself, is this true?

Whilst recent empirical studies tend to support the hypothesis (Bartels et al 2005, Osberg et al 2006) that national policy generally reflects the preferences of high income over low income voters, surely governments don’t only make policies that benefit the highest earners?

Why?

Another crucial empirical finding in the literature is that voter participation is generally lower when economic inequality is higher (Solt et al 2009). This begs the question: Does low voter turn-out increase inequality, or is the causal mechanism the other way around?

The most important process institutional change from the 1970’s onwards is the rapid rise in corporate-business lobbying and the decline of organized labour.

Declining mass membership

Economists usually focus on how trade union membership contributes to greater equality through their bargaining effect on lower wages. Low to median income earners who are members of a trade union earn more than their equivalent in non-union firms.

Over the past 30 years, mass membership organizations (trade unions, political parties) have atrophied and been replaced by the professional management of advocacy/lobbying groups. The organizational capacity of business has expanded, whereas the organisational capacity of labour has declined.

unions

But can we conclude that this socio-structural shift has led to major changes in the governance of political economy, and rising economic inequality?

Hacker and Pierson (2010) say yes, for the USA.

Winner takes all

Their empirical research demonstrates that change in the following four policy arenas has contributed toward rising inequality:

  1. Fiscal/Taxes. Most tax cuts for super-high incomes were the outcome of successful lobbying by anti-tax groups and free market think tanks, such as the Cato Institute.
  2. Labour relations. Private sector unionisation has virtually collapsed in the US. Public policies have never been updated to stem this decline. Governments actively avoided intervening to stem the decline.
  3. Corporate governance and executive compensation. Total compensation for the top three executives in the US has skyrocketed since the 1980’s. There has been no-intervention from government to stem the rising power of managerialism.
  4. Financial de-regulation. The rise of finance is virtually synonymous with the rise of winner takes-all. In 2005, five hedge fund managers made $500m. The average managerial salary of the top 500 S&P is $30 million. FIRE (finance, insurance and real estate) have more lobbying and campaign finance resources, and have actively shaped policies of financial regulation.

Conclusion

Explaining the winner takes-all dynamic (the growth in the share of the top decile/centile in national income) requires a political perspective that sees modern capitalist markets (big firms) and electoral democracies (state/party elites) as deeply interconnected.

This is what we call the study political economy.

On the one hand, governments (and political parties) actively shape and influence markets through a range of public policies. But on the other hand, private business interest groups actively shape how political authority is exercised.

Economists generally explain rising wage inequalities as the outcome of impersonal market and technological forces (markets). Recent political science research give priority to the role of the median voter (politics).

I have suggested that economic policymaking is more related to how corporate-financial interests are capable of shaping public policies (taxes, finance and labor markets) to advance their own economic interests (business-state relations).

The decrease in the top marginal tax rate of very high incomes in the US is a case in point. This is  what Pepper Culpepper (2016) calls  ‘quiet politics’, whereby ‘instrumental power (lobbying)’ and ‘structural power’ (capital-resource dependence) influence decision making. This “power” cannot be directly observed in electoral behaviour.

In the Irish case – think about the role of the IFSC Clearing House Group (now called the Industry Advisory Group) in shaping the Irish governments policy on whether or not to accept a coordinated financial transaction tax in Europe. Or think about the influence of the private real estate companies/lobby groups in housing policy.

Lecture slides: Lecture 13

Lecture 12: Inequality and the 1% in Europe and the USA

Introduction

The increase in income inequality since 1970 has not been the same everywhere. Why?

Political and institutional factors play a key role in shaping cross-national variation between countries. Explaining this difference is a core part of the study of comparative political economy.

To illustrate this, let’s examine the evolution of top incomes in France and the USA.

Figures 8.1 and 8.2 depicts the share of the upper decile (and centile) in national income in France (the trend in France is broadly similar for most continental European countries).

The reduction of inequality in France

Four observations stand out from this data:

  1. Income inequality has greatly diminished in France since the Belle Époque. The share of the top decile in national income declined from 45-50% on the eve of WW1 to 30-35% today. This does not mean France is an equal society but it shows that the society of the 19th century was deeply inegalitarian.
  2. The compression of income inequality was entirely due to diminished top incomes from capital. If we only look at wage inequality we’ll see that this has remained stable over time. The least well paid have always received around 25-30 percent of total wages. This has not changed that much over time.
  3. In particular, the share of the top centile (the 1%) in national income has greatly declined over the 20th century. If top incomes from capital (the 19th century rentier class) had not diminished, income inequality would not have declined the 20th century. Hence, it’s the fall in capital income that explains the fall in inequality.
  4. There is no natural equilibrium in the shape of the income distribution. It is shaped by politics, public policy choices and institutions.

The reduction in inequality in France during the 20th century can be explained by what Piketty calls “the fall of the rentier” and the collapse of very high incomes from capital. No generalised structural process of wage inequality compression has occurred.

The different worlds of the top decile

Figures 8.3 and 8.4 depicts the composition of incomes for the top decile in France in 1932 and 2005.

We can see that a significant change has occurred. Today, one has to climb much higher up the social hierarchy before before income from capital outweighs income from labour.

Income from capital only assumes decisive importance in the top one thousandth or 0.1%. The top decile has changed from one occupied by land owners to those employed as ‘super managers’.

In the top 9 percent in France you will mainly find individuals who earn 2-3 times the average monthly wage ($2,000). In other words, this group earns, on average between $4-6,000 a month.

These are mainly private sector managers, doctors, lawyers, senior officials and university professors.

  • Remember it is pre-tax!

To make it into the top half of the 9 percent requires attaining an income 4-5 times the average monthly wage ($8-10,000 a month).  This includes a lot of senior business-finance managers and corporate lawyers.

To make it into the top 1 percent it is necessary to earn an income that is 7-10 times larger than the average monthly wage ($15-20,000 a month).

But to make it into the top one thousandth, it is only those who substantial amounts of financial capital assets are only like to reach this level of income.

Labour market changes

Sometimes the quantitative must become qualitative to understand the social world within which we live.

Previously, the lowest  wage earners were farm labourers and domestic servants. Today the lowest-paid jobs are in the service sector: retail, catering, hotels, leisure, security and cleaners.

The occupational composition of the labour market has been fundamentally transformed  over time, but the structure of wage inequality has barely changed at all.

The bottom 50 percent still take the same share of national income

The 1 Percent

The top decile always composes two different worlds: the 9% in which income from labour dominates, and the 1% in which income from capital becomes more important.

This is not to say that someone in the 9% earns nothing from capital.

A senior manager on an income of $5,000 per month might rent out an apartment at $1,000 per month, and/or hold shares in her firm. This is a monthly income of $6,000. 80% of her income will come from labour and 20% from capital.

Most capital-income that supplements labour-income among the 99 percent comes from real estate. In the top 1% it is primarily business and financial, such as the dividends and interest from mobile capital.

In the top one thousandth it is almost entirely a return on financial dividends.

Large fortunes primarily consist of financial assets (stocks and shares in partnerships).

Tax evasion

It is important to note that figures 8.3 and 8.4 are pre-tax returns and therefore the estimates are based solely on income from capital that is reported in national tax returns accounts.

Actual capital income is under-estimated, owing to large scale tax evasion (it is much easier to hide investment income than it is is to hide wage income).

This can be achieved by using foreign bank accounts in countries that do not cooperate with the country in which the taxpayer resides and using quasi-legal tax-exemption strategies on whole categories of capital income.

It is extremely difficult to measure capital income. Very large capital income fortunes are often inherited, and off shored.

France since 1980

The long-term stability in wage inequality should not mask short-term fluctuations.

For example, after May 1968 Charles De Gaulle’s government increased the minimum wage by 20%. It was then indexed to the average wage such that the purchasing power of the low paid increased by more than 130 percent between 1968′ and 1983′.

Figure 9.1 shows the evolution of the minimum wage in France and the USA.

The political effect this had on the labour market led to a significant compression of wage inequalities. Libertarians would argue it creates unemployment.

From the late 1990’s, when the purchasing power of the bottom 50 percent stagnated, it increased for the top decile, primarily because of a new phenomena: super salaries at the very top (where purchasing power increased by 50 percent).

It’s also related to occupational upgrading.

Inequality in the USA

screen-shot-2016-10-19-at-11-44-20-a-m

Figures 8.5 and 8.6 represent the share of the top decile (and centile) in national income in the USA.

The most striking fact is that the USA has become much more inegalitarian than France (and Europe).

It is quantitatively as extreme as Old Europe in the first decade of the 20th century.

Inequality was at it’s lowest from 1950-1980 in the USA when the top decile took 30-35 percent of national income (the same as most of Europe today).

This is what Paul Krugman describes as “the America we love”, the period of the TV series Mad Men!

The explosion since 1980

Since 1980 income inequality has exploded. The shape of the curve is impressively steep (from 35 percent to 52 percent today). If it continues it will go beyond 60 percent in 2030.

Remember, this most likely under-estimates the returns to capital income because of tax evasion strategies.

The financial crisis did not impact on the structural increase in inequality at all.

Figure 8.6 shows that the bulk of the increase in inequality came from the 1% whose share in national income rose from 9 percent in the 1970’s to a staggering 20 percent today.

The top 1 percent include those making $352,00 a year. The 4 percent earn between $150-350k, and the 5 percent between $108-150k. The top 0.1 percent earn $1.5 million a year (US academic economists are usually in the top 4 percent).

Hence, the largest fortunes are in the top 0.01 percent.

Cause of the financial crisis?

Given that US income inequality peaked at extremely high levels in both 1929 and 2007 it seems reasonable to ask whether it was a causal factor behind the international financial crisis in 2008-2010?

This is a tough question to answer. But it is not unreasonable to assume that it contributed to financial instability. Inequality meant a virtual stagnation of the purchasing power of low to middle income earners. The implication is that low income earners had to substitute their declining wages with rising credit-card i.e debt.

This debt was repackaged and recycled into complex and increasingly uncertain financial markets, leading to increased risk and instability.

Larger share of the pie

From 1977-2007 (the eve of the crisis), the richest 10 percent appropriated almost three quarters of all economic growth.

The top 1 percent absorbed a staggering 60 percent of the total increase of US national income during this period.

For the bottom 90 percent the rate of income growth was less than 0.5 percent per annum. Is it possible to imagine a democratic society accepting such divergences between social groups for long period of time?

To get a sense of how this compares to Europe, see Figure 9.8.

The rise of the super-manager

What caused this rapid rise in inequality in the USA?

For Piketty, it was largely a result of rising wage inequalities and the rise of top salaries for super managers in large US firms (something we will discuss more next week). This accounts for two thirds of the increase. One third is associated with capital income.

For example, Anthony Noto, the COO of Twitter, received a total compensation package of $74 million in 2014. This was for a company that doesn’t even make much profit.

Is this skills-based remuneration (and therefore based on merit) or favourable tax treatment for the rich (i.e. based politics)?

Figure 8.9 and 8.10 depicts the precise composition of top income in the upper centile.

In 1929 income from capital was the primary source of income for the top 1%. In 2007 one had to climb into the top 0.1% for this to be true.

Qualitatively, who are all these people?

60 to 70 percent of the top 0.1 percent ($1.5m per annum) consisted of top managers. Athletes, actors, and celebrities make up less than 5 percent. It is more about super managers, and corporate executives, than it is about super stars.

Who are these super managers in the 0.1 percent? 20 percent work for banks and financial institutions whilst approximately 80 percent work in the non-financial sector.

Conclusion 

The debate that tends to dominate from a macroeconomic point of view (regardless of whether you think rising inequality is justified or not) is the stagnation of wages and productivity for the majority, rather than the exponential increase at the top.

Why does Piketty focus so much on top incomes?

Market economies require mass consumption. There are only two ways this can happen: wage growth or private debt (credit cards). Hence, there are huge macro economic implications for to rising income inequalities. It undermines capitalism.

lecture-12-3

 

Lecture 11: Income Inequality in Europe and the USA

Introduction 

In all societies income inequality can be unpacked into three interactive terms:

  • inequality in income from labour
  • inequality in income arising from the ownership of capital
  • and the interaction between these two terms

The causal mechanism, and normative justification, underpinning each of these is different.

What is Vautrin’s social lesson to Rastignac in Balzac’s Père Goriot? Why does Piketty use this story to explain the difference between work, merit and inheritance?

Vautrin explains to Rastignac that it is illusory to think that social success can be achieved through study, talent and effort.

He explains to Rastignac what income he can expect to earn, and what career paths he can expect to pursue in the various professions in France at the time, such as medicine or law, where learned competences/skills are more necessary than inherited wealth.

Vautrin claims that even if Rastingnac is talented and learns brilliant skills, he will never become wealthy. By contrast, the best strategy for social success is inheritance. On this basis he encourage Rastignac to marry Mademoiselle Victorine.

But to do this he must first murder her brother, to ensure that she gets the inheritance. Rastingnac is prepared to marry without love but not quite prepared to commit murder.

The key question being proposed by this moral dilemma is whether it pays to work if dishonesty, petty crime, inheritance and corruption matter much more for success. If such deep social inequalities exist, why should anyone bother to follow societal norms and market rules?

The structure of wealth and income hierarchies in 19th century Europe meant that the standard of living of the wealthiest greatly exceeded that of those who earned their income from labour.

Under such conditions why not be immoral and appropriate capital by whatever means?

The key question: work or inheritance? 

In these societies (which existed in all European countries until World War 1) the question of work/labour/skill did not arise. All that mattered was the size of one’s wealth and the size of one’s fortune, whether acquired through inheritance or marriage.

The shock of WW1 brought these patrimonial societies to an end. But Piketty suggests that rising wealth inequalities today mean they are making a comeback.

Democratic capitalism is founded on the normative belief that those inequalities that are based on merit, talent and hard work are more justified than other inequalities, such as inheritance.

For example, it is probably safe to assume that those who work the hardest in this class will most likely get the best grades. Everyone would rightly abhor a situation whereby grades were distributed on the basis of favour or social class.

Inequalities need normative justification.

Liberal capitalism is justified on the basis that free markets encourage fair and open competition, and that rewards are distributed on the basis of hard work, not corporate influence and power.

The core question to ask yourself over the coming weeks is whether we live in a society where social class matters more than hard work and merit? Do we live in a meritocracy? Does this vary by country, region and city?

For example, ask yourself which countries have the highest levels and lowest levels of social mobility.

Inequalities with respect to labor and capital

To answer these questions we need to distinguish between those inequalities that arise from selling labour and owning capital. Lets remind ourselves of some basic trends and concepts.

  • Income can be expressed as the sum total of all income from labor (usually wages and salaries) and capital (usually rent, interest, capital gains).
  • Total income inequality is the result of adding up these two components: inequality of income from labour and inequality of income from capital.

The more unequally distributed both of these are, the greater the total level of income inequality.

It is not always true that individuals with high income from labour/wages have a high income from capital, and vice versa. Jane Austen’s heroes owned so much capital (land) that they did not have to work. They had no labour income. They didn’t need a wage.

The difference 

There are two reasons why we need to understand these differences.

  • First, for normative reasons, the justification of inequality arising from labour effort is totally different from inequalities associated with inherited wealth and owning capital. There is probably only one Messi in the world. We tend to accept that it is justifiable that he earns a huge labour income from his very particular footballing skills (but not his tax avoidance).
  • Second, the causal mechanism that explains how rising wealth and wage inequalities, and how they change, are totally different.
    • In the case of wages/labour, what matters most is the supply and demand for different skills within a given labour market; the quality and type of the educational system in place; the rules and institutions of the labour market; the strength of trade unions and the structure of collective bargaining.
  • In the case of the inequality that arises from income from capital, what matters most are cross-national differences in the organisation of capital/finance markets; savings and investment behaviour;  laws on inheritance; and the operation of rental and housing/land markets.

Inequality has multiple dimensions and different mechanisms and cannot be adequately captured in unidimensional indicators.

Synthetic indices such as the Gini coefficient (ranging from 0-1) tend to lump all of these different things together. We are going to use distribution tables, which express inequalities in terms of social class. To quote Piketty directly:

distribution tables allow us to have a more concrete and visceral understanding of social inequality. They emphasize the shares of national wealth and income held by different groups, as well as an appreciation of the data to study these issues…the Gini coefficient gives a sterile and atemporal view of inequality.

Inequalities: some orders of magnitude 

There are two regularities/trends in the study of income inequality.

First, capital income is always more unequally distributed than labour income. This is the case in all time periods and all countries, without exception. The ownership of capital is significantly more concentrated than labour. Therefore, by definition, it is more unequally distributed.

Second, the concentration of capital ownership is explained mainly by inherited wealth and its cumulative effects (it is easier to save if you inherit an apartment and don’t have to pay rent).

inequalities with respect to labour income (wages) always seem moderate whereas inequalities with respect to capital always seem more extreme.

In public discourse we tend to think and talk more about wage inequality, primarily because most of us don’t experience capital inequality in the same way. Just think of the media coverage given to the Dublin Bus drivers wage demand, and the coverage given to massive increases in asset/capital prices.

Inequality of income distribution 

Tables 7.1, 7.2, and 7.3 chart the distribution of inequality from labour income, capital income, and total income.

They give an indicative picture of low, medium and highly unequal countries. Note: they are before taxes.

The top 10% of the labour income distribution usually receive 25-35% of total labour income, whereas the top 10% of capital owners usually receive 50% of all wealth (and in some societies as much as 90%).

Lets examine each of these distribution tables in turn (inequalities of labour income, capital income and the sum total).

Table 7.1 illustrates that in societies where labour income inequality is low (Scandinavia in the 1970’s), the top 10% received 20% of labour income, the middle 40% took 45% of labour income, and the bottom 50% took 35%.

In real terms: if average pay is €2,000 per month, the top 10% would take €4,000 (the top 1% would take €6,000) the bottom 50% would take €1,400 and the middle 40% would take €2,250.

Labour income is almost entirely earned wages and constitutes around three quarters of all national income. Most people live off their wages, not income earned from owning capital.

Piketty uses deciles (10 percent) and centiles (1 percent) to discuss distribution and inequality. These may lack the poetry of peasants, nobles, elites, workers and bourgeoise. But they enable us to make clear statistical comparisons across time and space.

Top decile/centile 

When discussing the top decile it is essential that we distinguish between the top 9 and 1 percent.

This was one of the major innovations of Piketty. He demonstrates that it is the top 1 percent, or more precisely the top one thousandth, where most of the change (inequality) has taken place, over the past 30 years.

Remember the top centile is the top 1 percent. This means that in the USA, with a population of 320 million, the top centile is 2.6 million individuals (adults). This is a numerically large group of people, capable of significant political influence.

The USA

The one country that stands out from table 7.1 is the USA,  where the inequality of labour income has broken historical records.

In real terms, what this means is that in the USA if average pay is $2,000 per month:

  • The top 10% would take $7,000 ($24,000 for the top 1 percent),
  • The middle 40% would take $2,000
  • The bottom 50% would take $1,000.
    • If these trends continue the top 1 percent could effectively employ the bottom 50 percent as domestic servants.

Think about these magnitudes. In Sweden the bottom half of the population earn $1,400 whereas in the USA it is $1,000.

This is a 40 percent difference, which is a significant amount. If we take into consideration the difference in the price of third level education, and the cost of public services, this income difference is likely to have a significant impact on equality of opportunity (and social mobility).

Women are significantly over-represented in the bottom 50 percent. What this suggests is that class-based inequalities are also gender-based income inequalities.

Looking at table 7.1 we can probably conclude that it is better to be a low wage earner in western Europe than to be a low wage earner in the the USA.

Why do different countries have different attitudes toward social inequalities?

Inequality of capital ownership

Table 7.2 shows that inequalities with respect to wealth and capital ownership are even more extreme.

In Europe the top decile typical own 60% of wealth, the middle class own 35%, whereas the bottom 50 percent own 5% of wealth.

In the US, the top decile typically owns 70% of wealth, the middle class own 25%, whereas the bottom 50 percent also own little more than 5% of wealth.

It is important to ask whether an optimal distribution of capital ownership can exist? Can normative political theories inform these debates (on preferences toward efficiency and equity). Think  about John Rawls.

In real terms, if average net wealth is $200k (divided into real estate and financial assets) this would imply that in the US:

  • The top decile would own capital worth $1.2 million
  • the top centile would own capital worth $5 million.
  • The poorest 50 percent would have net wealth of less than $20,000.

The importance of housing as a form of wealth decreases the further one goes up the income distribution. Housing is the asset of the middle class, whereas true wealth/fortune almost always consists of financial and business assets.

The growth of a propertied middle class was the principle structural transformation of the distribution of wealth (and politics) in the 20th century.

In the 19th century, and right up to WW1, there was no middle class. Almost 90 percent of national wealth was owned by the top 10 percent. The vast majority of a society’s assets were owned by an elite minority.

Nevertheless, despite the emergence of a middle class, table 7.2 shows that inequality in the ownership of capital remains extreme (the top decile own 60 percent of national wealth in Europe and 70 percent in the USA).

Inequality of total income

Table 7.3 shows inequality of total income (and the one that you will most often hear in public debate) with corresponding Gini coefficients.

Is it possible to imagine a society where the concentration of income is much greater than this? Could we imagine a democracy where the top decile appropriates 90 percent of all national income?

Democratic societies are clearly capable of accepting high levels of wealth inequality, probably because capital-income only constitutes one quarter to one third of national income.

But if the same level of inequality (top decile owning 90 percent of all output) applied to total income then surely a democratic revolution would occur? Or would it?

Table 7.3 shows that the USA may set a new record on income inequality in 2030. The top decile may take 60 percent whereas the bottom half of the population would barely get 15 percent.

Conclusion

Lets return to our opening question on merit versus inheritance. How are each of these inequalities justified? It is the justification of inequality that matters most in a democratic society.

One way to think about this is to compare high-inequality societies, such as the US today, with Europe in the 19th century.

19th century Europe was a hyper-patrimonial society where high incomes from capital (and inherited wealth) dominated.

The new high levels of inequality in the USA  emerge from high incomes from labour (super-managers).

If these co-evolve, as Piketty suggests they will, the 21st century will reach levels of inequality not seen since the 19th century. This is why the original title of the book was “the return of patrimonial capitalism”.

Growing inequalities in labour income are assumed to be justified on the basis of merit (better skills and new technologies). But is this true?

Next week we look at the composition of top incomes in Europe and the USA.

Lecture slides: Lecture 11

Data on Ireland: Ireland – 2018

 

Lecture 10: The Return of Neoliberal Capitalism

Introduction 

In this lecture we will seek to answer three questions:

  • Why the wealth-income ratio has returned to historically high levels?
  • Why it is structurally higher in Europe than the USA?
  • What does this suggest about the future of wealth accumulation in the advanced industrial economies of the western world?

The determinant of wealth/income ratio

To answer these questions we have to identify the determinants of the capital/income ratio over the long-term.

Piketty’s core claim is that the capital/income ratio is related to the savings rate and growth rate.

The relationship is so strong that he calls it the second ‘law’ of capitalism,  β = s / g .

β = s / g means that the capital/income ratio is equal to the savings rate divided by the economic growth rate.

  • β = capital/income ratio
  • S = savings rate
  • G = growth rate

If a country saves 12 percent of its national income every year and it’s economy grows by 2 percent, the long-run capital income ratio = 600% (12 divided by 2).

Basically a country that saves a lot, and grows slowly, will accumulate a large stock of capital relative to income. In turn, this will have a significant effect on the structure of society and the distribution of wealth.

For Piketty, low growth and a higher-savings rate (by households and corporates) is responsible for the variation in the capital/income ratio between Europe and the USA, and the main explanation for rising capital/income ratios since WW2 (in the long run).

If the economic growth rate falls to 1 percent and the savings rate remains 12 percent, β will equal 12 years national income or 1200% (12 divided by 1). But if the rate growth increases to 3 percent then β will equal 4 years income, or 400% (12 divided by 4).

For Piketty, this is the long term driver of wealth accumulation.

Note: I tend to disagree. Political institutions are, arguably, far more important in  explaining the distributive effects of economic growth, whilst asset price fluctuations (price effect) are just as important as the volume effect (savings rate).

Piketty’s argument arguably applies in the very, very long, but it is not a very useful mechanisms to explains the dynamics of global financial capitalism in 21st century.

But it all depends on the time period under examination. Asset prices matter more in the short run (30 years), but maybe less so over the long run (100 years). Hence, it is questionable whether “laws” across time/space exist at all. It’s all about politics.

The case of Ireland

But what does all of this mean, in real terms, for the structure of political economy ?

Is it not the case that a high capital/income ratio, and a large stock of wealth, benefits society? Does it not imply that there will be more investment and more jobs?

Not necessarily. It all depends on the distribution of capital, and whether or not the owners of societal resources have the incentive to use capital productively. This brings us back to the conflict between public and private capital in a democracy.

For example, a country will not gain from a large wealth/income ratio if it is all tied in up in housing capital (i.e. rising house prices that make homes unaffordable are not necessarily a sign of a developed democracy).

From a political perspective, if wealth is concentrated in a few hands, then the economic resources of a society are not efficiently distributed. It is not likely to be put to productive use. It might be hoarded by the rich to consume luxury goods.

Think about it another way, how much of Ireland’s capital from 1998-2008 was invested in productive investment?

Between 2000-2008, the total capital stock in Ireland increased from  €228 to €477 billion. According to Davy Stockbrokers only €50 billion was spent productively.

72 percent of the increase (or  €188 billion) went into housing.

Of the €50 billion that went into productive investment, two thirds of it (€33bn), was invested by the state: roads, education, energy, water-waste management.

Productive private sector investment (those investments that contribute to long-term productivity gains, and hence long-term improvements in living standards) made up a meagre €17bn of the total capital stock.

Davy Stockbrokers conclude that the Irish private sector, during the boom years of the Celtic Tiger, for the most part, wasted valuable societal resources. Today, the capital stock is rising again, and once again it is almost entirely driven by the rise in house prices.

See the CSO data.

The two supposed ‘laws’ of capital

β = s / g provides a logical historical account of the structural evolution of capital. It’s worth studying, and considering. So let’s take it for granted, for the moment.

The US has a higher demographic growth rate and lower savings rate than Europe, leading to a lower capital-income ratio.

It is important to note that this matters in the very long-run. The real accumulation of wealth takes time, particularly at the country-level. History will matter a lot.

Further, it is only valid if asset prices evolve in tandem with consumer prices. This means that it assumes that capitalism, in the long run, is a stable market economy, and not driven by boom-bust cycles (see Hyman Minsky).

It is also dependent on certain assumptions about the savings rate (s).

Furthermore, it does not explain the short-term shocks to capital, and the short term fluctuations in wealth/prices (which are deeply political!).

Capital income

But how do we explain the amount of income that accrued from the ownership of capital/property, and how much of this is included in national income (i.e. the amount of income that comes from the ownership of property as opposed to wages)?

Piketty proposes another “law” to explain this.

He says that the ratio of capital income in national income (a) is equal to the average rate of return of capital (r) times the capital/income ratio.

a = 30 percent, when r=5 and β=6

We can write this as follows: α = r X β  Note: it is a pure accounting identity.

Capital since 1970

Figure 5.3 indicates the annual change to private capital in the eight richest countries from 1970-2010.

For Piketty this data suggests that β varies constantly in the short-run but tends toward an equilibrium in the long run.

Capital asset prices (stocks, finance and housing prices) are  volatile. They can make a country look wealthy. But over the long-run, for Piketty, these balance out.

This is a standard liberal classical economic assumption.

But the price of capital is not a ‘natural’ phenomena. It is a human construct. Think about the different valuation of German firms vis-a-vis US firms.

In the study of political economy there is a tradition, which can be traced back to Hyman Minsky that suggests the fluctuation in boom-bust cycles of wealth is consubstantial with the history of capitalism itself. Markets are defined as erratic, not in equilibrium.

This is because the ownership of economic resources, and who stakes a claim to national income and national wealth is conflictual, not harmonious.

Just think about the impact of central banks quantitative easing (QE) on the price of assets since 2008, and the impact this has had on wealth accumulaiton.

Or think about the Japanese speculative bubble in the 1990s, and the bursting of the dot-com bubble in the US in the early 2000’s.

Discuss:

Is Piketty right to assume there is a long-term trend toward an equilibrium in the capital/income ratio?

Moving on…

What the data does reveals, however, is that since 1970 private capital has returned. Piketty calls it the re-emergence of patrimonial capitalism (the original title of the book).

Keep in mind Piketty’s critique: he is suggesting that wealth matters more than hard work in shaping the politics of distribution today.

There are three reasons for this return of capital (measured in terms of higher capital/income ratios):

  1. Slower economic growth and higher savings (primarily retained corporate earnings) – long-term
  2. The privatisation of public wealth since the 1970’s – short-term
  3. The acceleration of real estate and stock market prices since the 1990’s – short-term

Savings since 1970

Table 5.1 indicates the average value of growth rates and savings rates in the eight richest countries from 1970-2010.

The lower population growth and the higher savings rate in Europe and Japan explains why wealth-income ratios are higher in these regions of the world, when compared to the USA.

Over a period of 40 years, these savings and growth differentials will accumulate and create deep structural differences within societies (remember the importance of the compound rate of growth-interest). This is an automatic consequence of β = s / g 

It is crucial to note that that there are two components to private savings: corporate (retained earnings) and households.

See table 5.2 for the percentage difference in these savings rates within national income. Note the big differences between the UK/USA and Germany.

Retained earnings are profits of a company that are not distributed to shareholders.

They allow companies to reinvest in themselves; rather than pay out profits as dividends to their shareholders, which are usually more heavily taxed.

In the last few years, Silicon Valley increasingly use their profits as “share buybacks”. Basically, they buy their own shares to drive up the stock (market value) of their firms.

Privatisation 

The second complementary factor that explains the comeback of capital is privatization. 

Figure 5.5 shows the ratio of public and private capital to national income in the eight richest countries of the world. The data suggests that the revival of private wealth is partially due to the privatization of public wealth.

  • The decrease in public wealth equals approximately an increase of around one fifth or one quarter the increase in private wealth.

The case of Italy is particularly clear.

This reflects an increase in the debt owned by one portion of the Italian population, and their claim on another portion of the population.

Instead of the wealthy paying taxes to fund the deficit they lend government money at interest – increasing their own private wealth.

At a global level, the most extensive privatizations took place in the former Soviet Bloc.

The stock of capital in these countries was the same in the 1970’s and 2000’s (3-4 times national income) but the public-private split was completely reversed.

The rise of Russian Oligarchs obviously had nothing to do with the β = s / g  and was purely driven by privatization (and asset stripping), and close state-business ties.

Again, it was about politics.

The rebound of asset prices

The third complementary factor that explains the comeback of capital  is the historic rebound of asset prices, associated with global financial liberalisation.

The increase in asset prices from 1950-2010, largely compensated for the decline in asset-prices from 1910-1950.

The price of capital-assets is heavily influenced by political decisions, policy choices, and economic institutions, such as rental control laws (real estate) and corporate governance laws (corporations), and the liberalisation of capital accounts.

Remember our discussion about Germanylast week. There is no such thing as a natural market price. Private property is a human regulatory-legal construct.

Multinational corporations can be conceived as aggressive profit seeking business actors that actively shape the market in their own interest, or they can be conceived as functional utility maximisers, improving economic efficiency.

It all depends on your political and normative perspective.

We don’t know where capital prices are headed in the future. For example, we don’t know if house prices will tumble. But we do know that they cannot increase indefinitely.

This is why many critics of Piketty argue that he is overly reliant on the concept of “equilibrium” and does not appreciate the boom-bust nature of the capitalist cycle.

Prices as a human construct 

The market value of a firm is its stock market capitalization.

The accounting value of a firm is it’s assets (such as buildings) minus liabilities, net of debt. These are usually the same when a company is created. But they diverge over time.

The divergence is largely dependent upon whether financial markets are pessimistic or optimistic about the profitability of the company.

The ratio between market and book value is known as Tobin’s Q. This has tended to increase in all rich countries.

The main point to remember is that:

  • The rebound in capital-asset prices (stocks and real estate), since the 1970’s, accounts for between one third and one quarter of the increase in the capital/income ratio (but with significant variations between countries).

In terms of the capital/income ratio, Japan set the record set in 1990, but was recently beaten by Spain, where private capital equalled 8 times national income.

In both cases, the rapid rise in wealth/income ratios can be explained by the emergence of a housing-property bubble. Ireland was similar.

Summary 

Hence, for Piketty the comeback of capital, measured by rising wealth/income ratios, can be explained primarily by (1) and complemented by (2) and (3).

  1. Slower growth, higher savings (primarily retained corporate earnings) – long-term
  2. Privatisation of public wealth since the 1970’s – short-term
  3. Acceleration of real estate and stock market prices since the 1990’s – short-term

In popular discourse, the political and policy choices that liberalised the market, and enabled a return and rise of private capital is often referred to as “neoliberalism”.

Global imbalances

Finally, it is important to note that the sharp increase in national capital is primarily an increase in domestic capital.

Figure 5.7 shows that it is only really Germany and Japan that have accumulated net foreign assets. This accounts for between 50-70 percent of their national income (and an automatic consequence of their large trade surpluses).

International cross-national investments are particularly important in Europe. If we look at capital flows within the Eurozone, post-2000, we get a pretty disturbing picture.

In a global world of financialisation and cross-border capital movements every country, to some extent, is owned by another country to some extent.

Net international investment positions reflect this.

In the 1970’s, the total amount of financial assets and liabilities owned by households and firms barely exceeded four times national income. By 2010 this had increase to a staggering 15-20 times national income.

Within Europe this inevitably leads to perceptions that countries (Greece) are owned by other countries, such as ‘German banks’.

Ireland’s net international investment position is staggering.

This is primarily because of the impact of the IFSC. These debts-liabilities are in part related to fictious financial flows, associated with corporate tax avoidance strategies.

Conclusion

How important are ideas in explaining the politics of economic change?

To conclude, what about the future?

What will the global capital-income ratio be in 2050? The law β = s / g implies that it will logically rise and could reach 19th century levels by the end of the 21st century.

See figure 5.8.

The lecture slides can be downloaded here.lecture-10

Lecture 9: The Rise of Democratic Capitalism (B)

Revision 

Lets remind ourselves of Piketty’s core argument. He suggests that wealth inequality is growing because capital is accumulating faster than income, in Europe and the USA.

This can be measured by the rise in wealth-income ratios.

As we seen last Wednesday, national wealth is equal to 5-6 years national income in most European countries (national income is around $2.5 trillion in France, hence multiply it by 6 to get a sense of the total capital stock).

What we observed in the last lecture is that the ratio of wealth to income over the long-run has remained table in Europe since 1800, with the exception of the period 1950-1980. This is where we observe a decline in capital-income ratios, or a shock to capital.

What we also observed is that despite the stability in capital-income ratios, the composition of capital (and wealth) has fundamentally changed. Housing-real estate and domestic/finance capital have replaced agricultural land. Capital has been transformed.

Introduction

In this lecture we will look at:

  • the shocks to capital in Europe from 1950-1980
  • the evolution of the wealth-income ratio in the USA
  • the importance of slavery in the origins of US capitalism

Figure 4.5 depicts national wealth in Europe from 1870-2010. This long term trend is useful as it captures the two waves of globalization that have shaped capitalist development (1870-1910 and 1980-present).

Germany, France and the UK are only three countries, but they can be considered representative of Western Europe, given that they constitute more than two-thirds of national income in Western Europe.

All the available estimates reveal a similar capital/income ratio for Spain, Italy, Austria and the Netherlands (Spain experienced a more rapid rise due in their capital/income ratios, much like Ireland, due to it’s housing bubble in the 2000’s).

The shock to wealth

What caused the shock to capital in Europe during the 20th century, which can be observed in the decline in wealth-income ratios?

One obvious answer is the physical destruction of buildings, factories and infrastructure during the two world wars.

In France, physical destruction was equal to one year of national income. In Germany, it was one and a half years national income. In Britain it was less than one years national income. Hence, physical destruction only explains part of the decline.

The budgetary and political shocks of the two world wars proved far more destructive to capital than war itself.

The loss of foreign capital-assets, the low savings rate and physical destruction explain two thirds of the loss of wealth, whereas the new forms of property ownership, and new forms of rental-regulation, explain the final third.

  • Capital regulations, decline in real estate and stock market prices = 25-33% of decline
  • Low national savings, loss of foreign assets and physical destruction = 66-70% of decline

It is very important to remember this, as it will help us to explain the rebound of capital-income ratios from the 1970’s, especially in the 1990’s and 2000’s.

The rise in capital-income ratios in the 21st century, I will suggest, can largely be explained by rising commercial and real estate prices. It is a price effect, associated with the liberalisation of financial markets.

Public policies

The period 1914-1945 was a dark period for the wealthy in Europe: The Bolsheviks defaulted on French loans, Nasser nationalized the Suez canal, and wealthy individuals across Britain were forced to sell their foreign colonial assets to make up for lost savings.

Those owning stocks and bonds lost a fortune when Wall Street crashed.

But from the 1950 onwards, it was not the external shocks that shaped the nature of capitalist development rather it was government fiscal and socio-economic policies, which reduced the market value and economic power of those who owned capital-assets.

Post war Europe was a form of state-directed capitalism, which gave birth to different national models of capitalism across North, West, East and Southern Europe.

In the West, real estate prices fell relative to the price of goods and services.

House prices stood at historically low levels, owing primarily to rent control policies, which not only meant that housing became significantly less expensive, but that landlords earned less on their properties.

The stock value of corporations and firms also fell to historically low levels.

The state nationalised industries, across various sectors of the economy. Dividends and profits were heavily taxed, whilst shareholders were weakened vis-a-vis other stakeholders, such as workers.

It was the period of “Keynesian demand management”, or “mixed market” economies, where the state took responsibility for guaranteeing employment.

This radical new role for the state can be observed directly in rising tax revenues (measured as a per cent of national income).

Post war Europe gave birth to the social state: public provision of health, education and eldercare, in addition to other social security policies.

The USA 

But what about the evolution of capital/income ratios in the USA? Figure 4.6 shows that “wealth” mattered less in the New World  (USA) than the Old World (Europe).

National capital was worth less than 3 times national income from 1770-1810, whereas it was worth 7 times in Britain and France.

What explains this divergence?

It can primarily be explained by the price of agricultural land. There was so much land in the US that its market value was worth very little. The volume effect outweighed the price effect (remember Ricardo’s scarcity principle).

Domestic capital was also worth much less. This is because the US population were predominately immigrants. They arrived without houses, businesses, machinery, tools or factories. It takes years to accumulate this type of capital.

Hence, from the beginning, the influence of accumulated (inherited) wealth was less important in America when compared to Europe. Land cost little and anyone could become a landowner.

All of this has probably contributed to the Jeffersonian ideal of the ‘small landowner, riding out west, free and equal’. The American dream was born.

But by 1910, national capital had begun to accumulate rapidly, particularly in real estate and industrial capital, such that it amounted to 5 times national income.

The US had become capitalist, and industrial, but inherited wealth still had much less influence over the economy than in “old” Europe.

The shocks of the 20th century also struck America with far less violence.

Capital shocks in the US

Capital-income ratios were far more stable, fluctuating between 4-5 times national income from 1910 to 2010.

It was only after the Great Depression and World War II did the structure of capital change. This was primarily because Franklin D Roosevelt specifically adopted policies to reduce the influence of private capital, such as introducing rent controls.

But unlike in Europe, the US did not adopt policies of nationalisation. It was not the same type of “state directed capitalism” that occurred in Europe.

Rather, from the 1940s onwards, a series of public investment programs were launched, in addition to sweeping changes in progressive taxation. Public debt increased to fund the war effort but this eventually returned to a modest level in 1970.

Figure 4.7 shows that America continues to have net public wealth i.e. its assets exceed public debt.

Overall, the capital-income ratio in the US is far more stable than in Europe. This might explain why Americans tend to have a far more benign view of capitalist development than Europeans.

In 2010, capital in the USA was worth around 4.5 times national income. National income in the US is around $17 trillion, whilst in the EU it is around $18 trillion. Hence, multiply 17 trillion by 4.5 to get a sense of what the overall value of national capital/wealth is (measured in terms of market prices).

Slavery

It would be a mistake to conclude our analysis on the structural transformation of wealth, and capital accumulation, in the USA and Europe without discussing slavery.

Thomas Jefferson didn’t just own land in Virginia, he owned 600 slaves. Slavery was eventually abolished in 1865.

In 1800 slaves represented 20 percent of the US population: roughly 1 million slaves out of a total population of 5 million. In the South, slaves represented 40 percent of the population: roughly 1 million slaves out of a population of 2.5 million.

By 1860 the slave population had fallen to 15 percent or 4 million slaves in a population of 30 million. This can be explained primarily by population growth in the north and west. In the south it remained above 40 percent.

What was the price of a slave?

Figure 4.10 shows that the total market value of slaves represented 1.5 years of national income in the early 19th century (this is equal to the total value of farmland).

Remarkably, this implies that slave-owners in southern US states controlled more wealth than the aristocratic landlords in old Europe.

Black slaves and the land they worked equalled 4 times national income in southern states. The northern (land capital) and southern states (slave capital) is the USA during their period were completely different worlds.

Remember southern blacks were deprived of civil rights until the 1960’s. Racial tensions in the US, arguably, goes a long way to explaining the peculiar development of the US welfare state, and the type of inequality that the US experiences today.

Further, it’s important to acknowledge that slavery was a significant factor that led to the particular trajectory of capitalist development in the US, as suggested by this research.

Next week we will analyze the comeback of capital and wealth inequality since 1970.

lecture-9