Lecture 1/2: The Political Economy of Capitalist Development

Introduction

One core question permeates political economy scholarship: how is it possible to combine capitalism with democracy? One produces stark inequalities in the distribution of income and property, whilst the latter, in principle, is based on egalitarianism (one person, one vote).

So why don’t the poor soak the rich? As we will see throughout this course distributive economics under democratic rules is anything but straightforward – a sizable middle class acts as a buffer against radical demands for redistribution.

For the moment it is sufficient to acknowledge that the distribution of wealth and income is a primary concern in the study of global and comparative political economy.

But what do we really know about how these have evolved over time?

  • Do capitalist market economies inevitably lead to the concentration of wealth in fewer and fewer hands as Marx thought in the 19th century?
  • Or do the balancing forces of growth and market competition equalize distribution as Kuznets thought in the 20th century?

Thomas Piketty’s main contribution to the study of global political economy – in his book ‘Capital in the 21st Century‘ – is to provide 200 years of data to answer these questions.

His conclusion is that economic inequality was exceptionally high in the 19th century, declined in the 20th century, and increased again in the 21st century.

Over time, the income of the wealthiest (those who own capital-assets, such as large property portfolios) has increased whilst the income of the majority has stagnated. But this was not the case in the 20th century, primarily because of the birth of the social state.

From a broader academic perspective, his core contribution is to put the question of distribution and inequality back into economics. This is what’s called political economy.

Core theory: R>G

The data in the book covers three centuries and twenty countries. This data has been carefully sourced from historical tax records, and is primarily concerned with measuring incomes of the top 1%, and which cannot be captured accurately in survey data.

Central to the book is the development of a new theory to explain economic inequality.

  • His core theory is that when the rate of return on capital (think about any asset that yields an income such as housing) exceeds economic growth, inequality grows (R>G).
  • The R>G inequality is not a market imperfectION, rather it is built into the structure of market economies and requires democratic intervention if it is to be avoided.
  • Basically, what it implies is that when left to it’s own devices, the free market will always end up being dominated by corporate capital.

We will analyse the pattern of income and wealth over time. What we will observe is that there is nothing inevitable about inequality (it declined in the 20th century). Rather the pattern reflects the changing relationship between the state and market.

This is what I refer to as the history of democratic capitalism, or capitalist democracy.

Class discussion 

Most people are implicitly interested in the question of distribution and usually have an preferences toward how much tax they should pay; how much inflation is tolerable; how much the state should spend on eduction; rising rental costs and the minimum wage.

For example, just think about the following questions:

  • How much monthly income does a student need to live well in Dublin?
  • Should the government regulate the price of housing rent?

Global

Now think about these questions from a global perspective. Average per capita monthly income in Europe is just over €2,000, whereas it is just €150 in sub-saharan Africa.

If all global income was equally distributed, how much would each person in the world get? How much does this vary by regional bloc (Africa, Asia, Europe and the USA)?

  • Take a guess. The answers are here.

Most people would not accept a world whereby 100 percent of all wealth (land, housing, finance, industry) was owned by 1 percent of the population. In all likelihood,  this would be not possible in a democratic society, with free and fair elections.

But what if 1 percent own 50 percent of wealth, or 60 percent, or 70 percent? Is there such thing as an optimal distribution of wealth and income? How much is tolerable?

We observe inequalities (good and bad) all around us, and these observations inevitably lead to political judgement. Normative interpretations cannot be avoided.

The barista who served you coffee this morning and the Wall Street banker experience the world in very different ways. Given their vastly different income they are likely to have very different political preferences toward taxation and government expenditure.

Put simply: electoral preferences are heavily influenced by social class and income level. However, electoral theories that narrowly based on the ‘median voter’  tend not very good at explaining aggregate distributional outcomes (and policy choices). Why?

  • Later in the course I will suggest that policy choices shaping distributional politics is better analyzed as a form of organized combat between different interest groups.

Purpose of the course

The distribution of income and wealth inequality varies significantly across time (history) and space (country). A core objective of this course is to provide you with the tools, and critical thinking skills, to study the politics of inequality systematically.

Patiently looking for facts and historical patterns can inform democratic debate.

  • But perhaps more importantly, they enable us to ask the right questions.

The classical political economists of the 18th and 19th century (such as Adam Smith, David Ricardo, Thomas Malthus and Karl Marx) were deeply concerned with the question of distribution, and the societal effects of capitalism.

They were experiencing the radical transformation of society brought about by increased demographic growth, the industrial revolution, poverty, and mass migration out of rural communities into city-towns.

To give a historical example of these debates think about the abolition of the Corn Laws in England, in 1846. This was a dispute about the price of grain, and reflected a political struggle between aristocratic landlords and an emergent manufacturing class in Britain.

The repeal of the Corn laws reflected an ideological debate on how to manage the changing relationship between the state and private markets – and how this would affect the political equilibrium of European society.

  • It was against this political and ideological background that over 1 million people starved in the Irish famine.

Relevance

As we will see over the duration of the course, few doubt that wealth and income inequality has increased in rich countries from the 1980’s, particularly in the USA.

  • The empirical dispute centers on how to explain this change.

In the study of economics the rise in inequality is usually explained by changes in technology (skills-based technological change).

In political science it is usually attributed to institutional changes in the bargaining power among social classes; weaker trade unions and a rise in corporate power.

But before discussing the politics of inequality, and the politics of advanced capitalism, we first need an agreed quantifiable measure of things. A large part of the debate on inequality centres of different ways to measure similar phenomenon.

This is the part of the course you will probably find most difficult. Be patient.

Measuring capital and income

Piketty uses two sources of data in his book: the distribution of income (I) and the distribution of wealth/capital (w). Wealth and income are not the same.

He then analyses the relationship between these two (capital/income ratios).

It is important to note that he uses the terms wealth and capital interchangeably in this books: a problem we will discuss later.

At the most basic level, there are two ways to earn an income: selling your labour (earning a wage) or owning capital that yields an income (renting out a house).

The data on top incomes (the 1%) is gathered from historical tax records whereas the data on national/average incomes is taken from national government accounts.

The total stock of wealth (capital) in a country equals all the land, real estate, financial and industrial capital that can be traded on an open market.

The richest in society tend to earn their income from owning capital not from working.

All of this income data is then collated into the World Top Incomes Database (WTID).

Main findings:

  1. We should be wary of economic determinism. The historical distribution of wealth and income is a deeply political process.
  2. The shocks of WW1 and WW2 reduced the inequalities of the 19th century.
  3. The subsequent post-war period of strong economic growth and the emergence of the welfare state in Europe was a very temporary period in the history of capitalism.
  4. The long term dynamics of capitalist development reveal powerful mechanisms of convergence (a decline in inequality) and divergence (growth in inequality).
  5. The forces that lead to convergence are investment in education and training; the expansion of public goods; and tax regimes aimed at redistributing market income.
  6. The forces that lead to divergence in income inequality are associated with the capacity of top earners to increase their incomes through lobbying and tax cuts. This means that the growth in inequality is not associated with having better skills.
  7. The dominant force that leads to a divergence in wealth and capital inequalities is R>G (where the rate of return on capital exceeds economic growth).
  8. R>G means that when the economy is growing slowly, inheritance and wealth accumulated in the past becomes a powerful force of inequality. T
  9. The implication is that inherited wealth grows in importance relative to merit.

Think about the following question: if inequality keeps rising, as Piketty suggests it will, what are the likely political consequences? Will democratic market societies accept a level of inequality that undermines a culture of meritocracy? What will the electorate vote for?

Main findings

Piketty’s main findings on the politics of ‘divergence’ are represented in the two most important graphs of the book:

  • Figure 1.1 shows the rise in income inequality in the US. The top decile claimed 45-50 percent of national income in 1910 before dropping to 30-35 percent at the end of 1940. By 2014 it had risen to a historical high of 52 percent.
  • Figure 1.2 shows the rise in capital/income ratios in Europe. This is more difficult to understand and I will explain it in more detail next week.

Both graphs depict a U-shaped curve, which illustrates that income and wealth inequality decreased in the 20th century and then increased in the 21st century.

A core part of this course is to try and explain this change over time.

Let me explain two things about figure 1.2.

  • First, it shows the total market value of aggregate private capital/wealth (primarily real estate and financial assets) net of debt, expressed in years of national income from 1870-2010.
  • Second, capital income = all income generated from profits, dividends, interest, and rents. The growth of an economy (G) = growth in national income or output.

In a capitalist society where R is greater than G, inherited wealth grows faster than income from labour. For Piketty, when this occurs, the entrepreneur becomes a rentier i.e. wealth is primarily accumulated through the ownership of assets rather than work.

  • The growth in capital/income ratios are important because they illustrate the structural influence of capital in society. Think about this in terms of housing

For Piketty the increase in the inequality associated with R>G has nothing to do with market imperfection. It is the logical outcome of a free market.

Conclusion

All of these technical terms will become familiar to you as the course unfolds. Don’t give up at first sight. Every discipline has its own language and it takes time to learn this.

  • Understanding statistics on income, wages, inflation, prices, expenditure, revenue and wealth is essential in a democratic society. Study hard and be patient.

The PPT slides to the lecture can be viewed here: lecture-1-2

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