Lectures 1/2: Capitalism and Democracy

Introduction

One core question permeates political economy scholarship: how is it possible to combine capitalism (free markets) with democracy (collective choice)? One produces stark inequalities in the distribution of income and wealth, whilst the other (the democratic state), in principle, is based on egalitarianism (one person, one vote).

So why don’t the poor soak the rich? There are a lot more poor people than rich people.

As we will see throughout this course, understanding the relationship between states and markets, under democratic rules, is anything but straightforward. A sizeable middle class can act as a buffer against radical demands for redistribution. Choices in the past create a path dependent effect, and the electorate often vote against their interests.

The puzzle

For the moment, all I want you to note is that the distribution of wealth and income is a big concern in the social sciences, and in particular, the study of political economy. For the next two weeks, I want you to think hard about the politics of inequality, and to ask yourself questions such as: what type of inequalities are justified? what are not?

The question as to who gets what, when and how (in terms of national income) is not just an academic concern. It has major public policy consequences.  As citizens, we want to know about wages, income, inflation, and cost of living. For example, you’ll certainly want to know how much you’ll be paid before you sign a contract to start a new job. You’ll also want to know how much tax you will pay on your income.

Whilst we all want to know about our personal income/savings and cost of living choices (i.e. at the micro household and individual level), social scientists also want to know about how these things evolve at the macro-level (i.e. across our societies).

There are two core concepts that permeate everything you’ll study for the next two weeks: income and wealth. Once you understand these concepts, you’ll then need to consider what they measure, and what type of indicators emerge from them.

We will define these systematically, next week. For the moment, use your intuition to try to understand these two basic concepts. Put simply, income is the flow of money in society (whether it is government spending, household spending, or wage earning). Wealth is the stock of property someone owns (whether it is private housing, public roads, or shares in a private legal firm).

Core questions

What do we know about the evolution of income and wealth distribution in the advanced capitalist societies of the western world?

Today, we know a lot more than we did 10 years ago, given revolutionary advances in technology. But before looking at the data, ask yourself some basic questions, which are central to this course. Three three basic questions that you should ask yourself are:

  • Do market economies inevitably lead to the greater concentration of income and wealth in fewer and fewer hands, as Marx thought in the 19th century?
  • Or, do the balancing forces of economic growth and market competition equalize the distribution of income and wealth, as Kuznets thought in the 20th century?
  • What is the role of the state, and other democratic institutions such as trade unions and collective bargaining, in shaping the distribution of market income?

In this course, we will use Thomas Piketty’s book, ‘Capital in the 21st Century‘, as a guide to answering these questions. His major contribution to the study of political economy, and social science, is to provide 200 years of data on the evolution of top incomes.

His core conclusion is that income and wealth inequality was exceptionally high in the 19th century (before democracy), then it declined in the 20th century (during the birth of the democratic state), but has since increased again in the 21st century.

We need to ask why has inequality increased so rapidly in the 21st century? Is it because of technological changes? Globalisation? Financialisation? Or politics?

Normatively, are these inequalities justified? If so, on what basis? If people get rich through inheritance, is it fair? If they get rich through hard work, is it fair?

Since the 1970’s, the income of the wealthiest (those who own large property portfolios), particularly in the USA/UK, has increased whilst the income of the majority has stagnated. But this was not the case during the 20th century. Why?

From a broader academic perspective, Piketty’s core contribution is to put the politics of of distribution back into the study 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 the incomes of the very top 1% of the population. These top incomes, usually involve wealth ownership, and are difficult to capture in survey data.

  • His core theory to explain the rise of economic inequality is that when the rate of return on capital (think about the ownership of any property that yields an income, such as housing) exceeds economic growth, inequality grows (R>G).
    • Basically, what this means is that when those who own property earn more from the rents of that property ownership, than those who earn income from working (i.e. through earning a wage), inequalities grow.
  • 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.
    • Hence, during the 20th century, governments liberalised global trade (buying and selling goods/services), but not financial capital.
  • Basically, what this theory implies is that when left to it’s own devices, the free market will always end up being dominated by corporate capital, unless the latter is restricted and regulated through democratic politics.

In the next 12 weeks, we will analyse the pattern of income and wealth, both historically within countries, and comparatively, between countries. What we will observe is that there is nothing inevitable about inequality. The changes that we observe reflect the changing relationship between the state and market, business and politics.  Or to put it another way; it reflects the ongoing tug of war between capitalism and democracy.

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 a preference toward how much tax they should pay; how much inflation is tolerable; how much the state should spend on education, healthcare and pensions; the cost of housing; rising rental costs and the minimum wage, to name but a few things.

For example, just think about the following questions:

  • How much monthly income does a student need to live well in Dublin?
    • How much of your income do you try to save?
  • Do individuals have a social right o housing?
    • Should the state or the market provide this?

For the next week, I want you to do a mini experiment. From the moment you leave this lecture hall, specify how much income you have to spend for the next week. Then keep note, and track precisely, how much of this income you spend.

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 and property (land, housing, finance, industry) was owned by 1 percent of the population. 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?

If a country has extreme levels of income and wealth inequality, does it distort politics? Can we call such a country a democracy?

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

Electoral preferences 

The bus driver who drove you to college this morning, and the Wall Street banker, experience the world in very different ways. Given their different socio-economic situations, they are likely to have very different political preferences toward taxation and government expenditure, trade unions and collective bargaining.

They will have different preferences toward economic redistribution.

However, one cannot assume that when they go to the ballot box their “left/right” economic preferences determines how they vote. They might vote on the basis of cultural values (i.e. for conservative nationalism, or liberal internationalism).

Electoral preferences are heavily influenced by education, social class and income level. However, electoral theories that narrowly based on the “median voter” tend not to be 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.
    • That is, economic policy is often shaped by elite-quiet politics, whereby organised interest groups directly and indirectly influence government policy, and not electoral coalitions.

Learning outcomes

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 income and wealth distribution, and the societal effects of capitalism.

They were experiencing the radical transformation within their societies 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. The British state chose not to intervene in the market.

The societal changes brought about by market technological change are all around us. Just think about the impact of automation on low and medium skilled jobs today.

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 1970’s, particularly in the USA.

  • The empirical dispute is how to explain this change.

In the study of economics, the rise in inequality is usually explained by changes in technology (and what’s often called, 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 the book: 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.
  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 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 (you’ll understand this language soon!!)
  • Second, capital income equals all the income generated from profits, dividends, interest, and rents. The growth of an economy (G) = growth in national income or output, which is often best considered in terms of productivity growth.

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

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s