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

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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.

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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

Lecture 8: The Emergence of Democratic Capitalism (a)

Revision  

Over the last week, we discussed the history of ideas underpinning classical and critical political economy.

In weeks 1-2, we found that, on average, the economy has grown by 1-2 percent per annum whereas the rate of return on capital is 4-5 percent. This means that in the long-term, the importance of capital (wealth) will increase relative to income (real economy).

This is not a market failure.

What it suggests is that when markets are left to their own devices they will produce the inequality R>G. The more ‘perfect’ the capital market the greater the R>G inequality.

This week we are going to analyze the structural transformation of wealth (public and private) in Britain, France and Germany, from 1870-2010.

To do this we will need to analyze the importance of public debt in shaping the dynamics of private wealth. Public debt is private wealth.

Introduction 

One way to analyze the importance of capital (wealth) within a society is to measure the total amount of capital stock as it relates to national income. This is expressed as the total amount of capital owned at a given point in time, divided by total yearly income.

This calculation gives us the capital/income ratio, denoted by the greek symbol β.

If a country’s total capital stock is equal to six years of national income, we write β = 6 (or 600 percent). If the stock grows, wealth grows. This in-itself is not a problem. It becomes a problem when the wealth/capital is owned by a small group of people.

Why? Because it suggests that important economic resources in society are privately owned by a small group of people, who may or may not use it productively.

When the rate of return on capital exceeds the rate of return to national income, the capital/income ratio, β, grows. Note that the capital-income ratio in most western capitalist democracies, today, is between 500-600 percent (or 5-6 times national income).

This means that in the UK, national wealth/capital equals 5-6 times, or 2.4 trillion dollars.

In the novels of the 19th century, the rate of return to capital (wealth) was widely discussed. Wealth was a stable monetary marker. In Jane Austen’s novels , wealth usually takes two forms: land and/or government bonds.

This form of wealth may seem old fashioned in a period of “dynamic entrepreneurial capitalism”. But have things really changed that much? Think about housing.

Private/public wealth

Owning a capital asset has one purpose, and this hasn’t changed at all. The purpose is to produce a reliable steady income.

That’s exactly what land and government bonds provided in the low growth, zero-inflation economies of the 18th and 19th century. Given low growth, and low inflation, these countries had high and stable capital-income ratios.

They were wealth dominated societies.

For Piketty, the implication of this, particularly during the 19th century, is that low growth economies are capital-dominated societies. Capital income from owning wealth (land/government bonds) accumulates faster than labour income.

But what exactly is a government bond that made these Jane Austen characters so wealthy?

It is a claim of one portion of the population (those who lend to government and receive an interest/yield) from another portion of the population (those who pay taxes to the government).

Government debt is always another person’s private wealth.

In the aftermath of the international financial crisis, taxpayers are regularly reminded that their state is in “debt”. But to whom exactly do taxpayers owe this money?

Ask yourself the following question: Has the structure of capital from the 19th century become more dynamic and less rent-seeking?

For Piketty, capital at its inception is always risky and entrepreneurial but evolves into rent when it accumulates into larger amounts.

To make this point he uses the character of Père Goriot (a classic Balzac novel). Goriot gets rich as a pasta manufacturer, and then invests his wealth in government bonds, only to be deceived and abandoned by his daughters.

Capital in Britain and France

Figures 3.1 and 3.2 illustrate the wealth/income ratio in Britain and France from 1700-2010, and demonstrate three important social facts about the economic structure of British and French society from the 18th-20th century (the countries for which we have the longest data).

  • First, the wealth/income ratio followed a similar u-shaped curve.

The total market value of national capital fluctuated between 6 and 7 times national income between 1800-1914.

After WW1, and up until 1970, it collapsed to 2 and 3 times national income.

It has since climbed back up to 6 times national income in 2010.

These are very large swings and reflect the serious distributional conflicts during the 20th century, when the ownership of wealth and capital was highly contested, politically.

Think about Acemoglu’s theory of social conflict in explaining economic institutions.

  • Second, despite the stability of wealth/income ratios, the structural composition of wealth has totally changed over time.

Capital-assets are no longer agricultural. They have been replaced by buildings, business, financial and real estate.

Remember national capital = farmland + housing + other domestic capital + net foreign capital.

What figures 3.1 and 3.2 demonstrate, most clearly, is the collapse in the value of farmland. But ask yourself what has replace this?

The collapse in agricultural land was replaced by a rise in the value of housing and domestic capital (the industrial/financial assets of private firms and government).

As I will suggest later in the course, Piketty under-estimates the significance of the price effect of housing capital as a determinant in rising capital/income ratios.

This is important, because it housing impacts political preference formation.

  • Third, net foreign capital was highly significant in the 19th century but not anymore.

British and French citizens could yield a significant income through colonial ownership.That is, rich citizens of these countries could increase their wealth through owning assets in their colonies.

The advantage of owning another country’s resources is that you can consume and accumulate without having to work. The colonies produced and the colonizers consumed.

With decolonization these foreign assets evaporated. The role of Western imperialism in capitalist accumulation, throughout the 20th century, is a core factor in explaining western European wealth. This is rarely acknowledged in economic textbooks.

Inference

The core inference from all of this is that national capital has preserved its value in terms of annual income but it’s composition has totally changed (from land to real estate and finance).

But does this structural transformation of capital imply that wealth has become more dynamic and more entrepreneurial? This is an important question to ask yourself.

Before we explain the revival of capital since WW2, we need to analyse the politics of public debt. To do this, we need to examine whether national capital (wealth) is publicly or privately owned.

Government debt

The division of property rights between government and private individuals (states and markets) is a very important political question. We usually only ever hear about government liabilities or government debt. But what about state/public assets?

Public assets (wealth) can be financial (think about the oil-producing sovereign wealth funds underpinning the Middle Eastern monarchies) or non-financial (think about this university). For the most part, states have more public debt than public wealth.

Britain and France offer two very different case studies on the relationship between public debt and private capital.

  • In Britain, at the end of WW2 (and after the Napoleonic wars) public debt was over 200 percent, but Britain never defaulted.

The British monarchy never collected enough taxes to pay for their wars.

Rather they raised revenue by borrowing from rich private individuals (thereby increasing the private wealth of their richer residents and in turn: rising capital/income ratios) rather than taxing them. Taxation was a 20th century phenomenon.

Britain’s economy grew at a steady rate of 2-3 percent from 1815-1914, so after a century, they eventually reduced their debt-GDP ratio, which was accumulated in the 19th century. In the 20th century they primarily got rid of public debt through inflation.

  • In France, at the end of WW2 (and after 1798), the French government defaulted and cancelled all of its public debt.
    • They choose to create a large public sector instead.

This meant that they took capital/wealth away from the private sector and placed it in the public sector.

Discussion

Think about the recent financial crash, and the post-crisis policy response in Europe, and the relationship between private wealth and public debt.

The Irish bank bailout cost 64 billion (40 percent of GDP), and was designed to cover the private liabilities of six financial institutions: AIB, Bank of Ireland, EBS Building Society, Irish Life & Permanent, Anglo-Irish Bank and Irish Nationwide.

The cost of the bank bailout was approximately €8,956 per person.

How does the Irish government (taxpayer) repay this debt?

Or more precisely, who pays it?

From a market perspective, it is far more advantageous to lend to governments and receive an interest/payment, than to pay higher taxes without compensation.

Inflation

Investing in public debt (buying government bonds) at 4-5 percent interest in a context of slow growth and zero inflation is a pretty good investment.

In the 20th century many governments, particularly those in France, borrowed from private investors to fund public services. The purpose of increasing public debt was to redistribute resources to lower-income households.

But this debt was evaporated (paid off) by inflation.

From 1914-1950, French inflation was approximately 13 percent per annum. This meant that a government bond bought in 1913 was worthless twenty years later.

Inflation enabled the French government to ‘inflate it’s debt away’, whilst simultaneously re-building their social state.

Germany did the same.

None of this is meant to suggest that redistribution by inflation is a good idea, or an optimal strategy to manage the public-private wealth dynamic. It cannot work indefinitely. But it is important to note that public debt is a vehicle of redistribution whether it is repaid or not. It’s a strategy to mobilise private wealth for public gain.

Public assets

Enough about public debt, what about the evolution of public wealth/assets?

Figures 3.3 and 3.4 reflect a steady expansion, albeit modest, of the economic role of the state in France and Britain.

The total value of public assets (primarily public buildings, national industry and infrastructure) rose from 50 percent of national income in the 19th century to approximately 100 percent in the early 21st century.

These public assets peaked during the interventionist years, from 1950-1980, and were then followed by major waves of privatization after 1980.

Figure 3.6 is indicative of the interventionist years in France.

It is important to keep in mind the changed ideational climate after WW2. The period of laissez-faire during the first era of globalisation, (1870-1913), was widely considered a policy failure that contributed to war and recession.

The French nationalized many parts of their banking and automobile sectors (the owner of Renault was arrested as a Nazi collaborator in 1944) after the war, giving rise to an economic system of ‘dirigisme‘.

From an economic ideas perspective, France considered the weakness of their state a causal factor behind German invasion, therefore they wanted to strengthen the state.

By 1950, public wealth in France was worth one year of national income whereas private wealth was worth two years of national income. The government owned 30 percent of the nation’s wealth.

France had a mixed economy, or capitalism without capitalists. The biggest firms were public not private. This all changed from the late 1980’s and 1990’s when the new era of Europeanization, liberalization and privatization was instituted.

Germany

How does all of this compare with Europe’s other ‘great nation’, Germany?

Figure 4.1 shows that the evolution is very similar.

  • First, agricultural land gave way to residential and commercial real estate.
  • Second, the capital/income ratio has grown steadily since 1950.

But note one important difference. Germany never had a net foreign asset position during the 19th century (it was not a colonial power), but it has amassed substantial foreign assets over the past few decades, primarily because of it’s large trade surpluses.

Germany’s net foreign asset position is equal to 50 percent of national income, a significant amount, and over half of this has been accumulated since 2000.

  • Germany, like France, got rid of its public debt throughout the 20th century via inflation, which averaged 17 percent between 1930 and 1950.

The hyper inflationary strategy during the 1930’s destabilized German society. This arguably underpins the paradoxical situation in Europe today. Germany is opposed to any price increase that exceeds 2 percent per annum, despite being the country that resolved its public debt in the past via the inflation mechanism.

Britain, on the other hand, always repaid it’s debt, and does not have the same fear of politically induced inflation. For example, the UK is happy to allow its central bank to buy a substantial portion of its public debt (monetary policy), regardless of the asset-price inflation effect.

Germany also engaged in large asset purchases of its banking and automobile sectors during the interventionist years of 1950-1980. The government owned almost 30 percent of national wealth during the decades of postwar reconstruction.

The state of Lower-Saxony still owns 15 percent of Volkswagen shares today (and therefore 20 percent of voting rights, given corporate governance and co-determination laws in Germany).

Conclusion

Figure 4.4 compares Britain, France and Germany. National wealth is equivalent to 4 times national income in Germany, compared to 5 and 6 in France and the UK.

But national savings are higher in Germany. What explains this paradox? How can a country with high-savings have a lower capital/income ratio?

It can be largely explained by two factors.

First, the very low price of real estate in Germany, which is kept in check by strict rental control regulations. Second, German firms have a lower stock market valuation, which is lower because workers have a stronger claim on the ownership of German firms.

This reflects the German ‘Rhenish’ or ‘stakeholder’ variety of capitalism, whereby firms are owned not just made up of private shareholders (the Anglo-Saxon model) but stakeholders such as trade unions, consumer associations and regional governments.

Lower stock market valuation does not imply lower social valuation, nor does it imply less economically efficient firms. Rather it reflects a politically different way to organise the market. It reflects the fact that “private property” is a legal construct.

Legal constructs are socio-political constructs.

We will examine this in more detail during the second half of the course, when we analyze the importance of ‘national models of capitalism’, a debate that has become more important in the aftermath of the great recession in Europe.

The PPT slides can be found here: lecture-8

Lecture 7: Critical Political Economy

Introduction 

The study of political economy, and political science, can be distinguished from the study of economics/econometrics because of it’s focus on:

  • Power
  • Institutions
  • Distribution

In terms of power: whereas economists tend to analyze the market in terms of Pareto-optimality, political economists tend to analyze markets in terms of whose interests are being served by a given set of economic arrangements.

In terms of institutions: political economists tend analyze the economy as a diverse set of institutions that vary across time (history), and space (country).

These institutions are the rules of the game that shape actor behaviour.

In terms of distribution: political economists study the market as a social construct whose conception is not based on natural laws but the primacy of politics.

They are primarily interested in the question: who gets what, when and how.

This tradition stems from Adam Smith but took a critical turn when Karl Marx published the first volume of Capital in 1867, fifty years after Ricardo published his Principles on Political Economy. 

  • Think about the year 1867. What was happening across Europe?

It was twenty years after the 1848 European revolutions, which swept across Italy, France, Germany, Netherlands, Poland, the Austrian Empire, and even Ireland.

What all of these nationalist revolutions shared was the attempt to overthrow feudalism and to replace it with more participatory forms of democratic government.

This gave birth to the nation-state as we understand it today.

The revolutionary fervour began in Milan when 70 people were killed whilst protesting against tax increases on tobacco, imposed by their Austrian rulers. These protests spread to Sicily, where local citizens demanded a liberal constitution to replace the autocratic rule of King Ferdinand II.

Before long people were rioting in Geneva, Paris and across several cities in what we now call Germany.

Historical context

It was against this background that Marx published Volume I of Capital.

Think about the context. England had the fastest growing economy in the world. Thousands had left the land to work in factories. All of these new labourers were living in urban slums. This is what inspired Charles Dickens to write his famous novel, Oliver Twist.

From 1840-1890 poverty was widespread, real wages were stagnant, whilst profits increased. It was not until the second half of the 19th century before real wages began to increase for the emergent industrial/working classes.

Keep in mind Adam Smith’s labour theory of value that we discussed last week.

National income (all earnings in a country) can be divided into wages, rent and profit. During this period of growth, the share of wages in national income did not rise.

The capital share of national income (industrial profits, land rents and building rents) increased massively in the first half of the 19th century.

As we will see from Piketty’s data, from 1870-1914 inequality stabilized at an extremely high level, marked by an increased concentration of wealth.

  • The industrial revolution gave birth to a period of rapid economic and productivity growth, stagnant wages and a growth in economic inequality.

This is the historical context that led Marx to write the ‘communist manifesto‘ in 1848.

The method

After this polemic, Marx spent the next twenty years writing Das Kapital, which he considered the first scientific attempt to systematically analyze the internal logical contradictions of the capitalist system (based on the Hegelian dialectic).

For Marx, the most important resource in a market economy is not land but capital.

He takes Adam Smith’s analysis and works through the logical outcome of commercial markets. He concludes that markets lead to centralisation not competition.

Keep in mind that Capital in 1868 was increasingly industrial (machines, factories) rather than landed property. Hence, contrary to Ricardo, for Marx there can be no limit to industrial capital. This led Marx to formulate his “principle of infinite accumulation“.

A free market for capital/money, when left to its own devices will keep accumulating and become more centralised. For Marx, this principle of infinite accumulation implies that capital is doomed to perpetual crises (in the Hegelian sense).

Why?

  • For Marx, either the rate of profit will steadily decline (leading to violence amongst capitalists) or capital’s share in national income would increase indefinitely (leading to workers revolution).
  • For Marx, there is no stable equilibrium in a capitalist society, it will “build it’s own gravediggers“.

The theory (M-C-M)

Let’s unpack this theory further.

First, it is crucial to note that Marx is in dialogue with Adam Smith. In chapter 2 of volume I he accepts the Smithean argument on exchange, reciprocity and private property and then proceeds to deconstruct it entirely.

He points out that contrary to the positive outcomes suggested by Adam Smith, competitive markets will lead to:

  • the centralization of capital (markets lead to corporations)
  • the concentration of capital (centralization leads to class power)

The entire book can then be read as a deconstruction of the system of free competitive markets, in order to show why they can never be ‘free’.

Marx, much like Smith, tell a story about capitalist development: the capitalist starts out with a certain amount of money. He then purchases two crucial commodities:

  • Labor power and
  • Means of production (raw materials, machines)

He then puts these two to work within a given technology to produce a fresh marketable commodity. This is then sold in the market place plus a surplus value to make a profit.

But it does not stop here. The capitalists does not consume all the profit as luxury. Rather he/she re-invests it to produce more commodities.

To do this, the capitalist must expand labour and apply new technologies to produce new and better commodities.

Why? For Marx the coercive laws of competition compels the entrepreneur to reinvest the surplus. If he/she does not he/she will be destroyed by his competitors.

The outcome is a simple formula for the circulation of capital: M-C-M. Money-commodity-Money.

The 5 crises tendencies 

For Marx the capitalist mode of production always leads to crises. It contains 5 major problems that lead to the following questions:

  • Money: Where does it come from?
    • Solution: Secure the legal-state
  • Labour: how to source supply and demand?
    • Solution: Weaken organised labour
  • Environment: How to deal with scarcity?
    • Solution: Invest in technology
  • Technology: The falling rate of profit?
    • Solution: Source new markets
  • Debt: How to keep the system liquid?
    • Solution: Ensure aggregate demand

Keynes would later suggest that the role of the state and fiscal policy can be used to stimulate the economy if the market is faced with a lack of effective demand.

What is important to note is that these blockage points within the capitalist mode of production need to be overcome.

For Marx capital is a flow, if you stop the flow, capital gets lost. This is why Marxian economists are critical of Piketty, who thinks of capital as a stock of wealth.

For Marx, capitalist politics is a perpetual class struggle over all of these factors that keep the system intact. If there is no resolution then stagnation occurs. Crises = Revolution.

Why Marx was wrong

Marx predictions on the inevitable demise of the capitalism turned out to be wrong. He assumed that capitalism would collapse. It didn’t.

This mistaken judgement is not so much related to his insightful historical analysis, but to his use of dialectical Hegelian method, which assumes, by definition, implosion.

At the end of the 19th and into the 20th century, wages gradually began to increase, and the purchasing power of workers spread everywhere.

In Western Europe, workers and citizens explored the alternative avenue of social democracy, rather than communism.

Marx did not anticipate the emergence of a propertied middle class, the social state, nor the emergence of new technologies, or a steady increase in productivity.

The balance of power among different classes associated with trade unionization complemented the emergence of a new power configuration, with a a relatively autonomous state apparatus with the capacity to tax and spend.

This gave birth to the social state as we understand it today. Or capitalist democracy.

What did he get right?

Marx’s principle of accumulation contains an important insight that contemporary economists have tended to ignore: competitive markets have a tendency toward the centralization of ownership and the concentration of wealth.

Just think about the influence of large corporations, such as Google.

The accumulation and concentration of wealth does lead to the concentration of power, which has destabilising effects in both politics and economics.

It would be naive to think that growing income and wealth inequality does not impact on equality of opportunity and democracy.

Why then have economists tended to ignore the distributional question?

Simon Kuznets 

The narrative during the 20th century shifted away from apocalyptic predictions to happy endings. It was now assumed that a rising tide lifts all boats.

Simon Kuznets predicted that income inequality would automatically decrease in advanced stages of capitalist development, regardless of the economic policy choices pursued by government.

This theory was based on US data from 1913-1948. It built upon Robert Solow’s (1956) theory of a “balanced growth path”.

Economists increasing assumed that all the core economic variables in society: output, incomes, profits, wages, capital, asset prices, would progress at the same pace.

In the end,  a market economy would benefit everyone, as it is the best way to achieve high levels of economic growth.

This was the opposite conclusion to Ricardo and Marx’s assumption of an inegalitarian spiral built into the process of capitalist development.

Kuznet’s was the first to analyze social inequality using sophisticated statistical and mathematical tools. His data (which Piketty has since developed) was based on federal income tax returns.

This allowed him to measure top incomes, particularly the income shares going to upper deciles and centiles, in the overall income distribution.

What he observed was a sharp decline in income inequality between 1913-1948.

In 1913, the upper decile (top 10 per cent of earners) claimed 45-50 percent of national income. By the late 1940’s this had declined to between 30-35 percent.

This decrease was equal to half the income of the poorest 50 percent of Americans.

This decline in income inequality shaped the debate on the politics of distribution in the USA, and various international organizations, throughout the Cold War.

Capitalism was clearly working for everyone whilst the Communist experiments were not. This was an important normative justification for market economies.

Kuznets curve 

Kuznets delivered a paper titled ‘Economic Growth and Income Inequality‘ to the American Economic Association, which gave birth to a new theory: the ‘Kuznets curve’.

This predicted that inequality would initially increase during industrialization and decrease at a later advanced stage of capitalist development.

The internal logic of capitalist development was now assumed to be one of equalization not wealth concentration Market competition leads to a balanced growth path.

As we will see in the coming weeks, it is true that wealth and income inequality decreased in the 20th century, particularly after the shocks of two world wars.

But it is also true that wealth and income inequality have since increased, everywhere, since the late 1970s. This is the opposite prediction of Kuznets theory.

The income of the wealthiest have reached extraordinary levels whilst the incomes of the vast majority have stagnated. This is now clearly observable in the data.

This table and graph illustrate the point.

The question we need to ask is why this has occurred?

Conclusion 

The important question we will now try to address is why there was a decline in inequality in the 20th century, and and a rapid rise during the 21st century.

There are two competing explanations: economists tend to focus on skills-based technological change. Political economists focus on politics and bargaining power.

What we will see over the coming weeks is that in the aftermath of WW2, various forms of progressive taxation, capital controls, collective bargaining, rents control, minimum wages and expanded social programs worked to redistribute capital across society.

These were the ‘happy days‘ of a growing middle class.

There is now growing skepticism about the assumption that growth is “naturally” balanced. There are clearly winners and losers. In the US, the top decile receives over 52 percent of national income (a new historical record).

What the data increasingly suggests is that the gains of “economic growth” are being distributed disproportionately to the top of the income ladder.

But to explain the U shaped curve of inequality from 1900-2013, we need to examine the structural origins of this inequality (1890-1913), which is what we will do next week.

The industrial revolution, in addition to the race to colonize the world, completely transformed the face of capital-wealth in Europe. Wealth was totally transformed.

The lecture slides can be found here: lecture-7

Lecture 6: Globalisation, occupational change, and changing class structure.

In this lecture we will analyse the socio-structural impact of technology and globalisation on social class, occupational change and voting behaviour.

We will argue that these structural changes have created new social class dynamics that shape socio-economic (left/right) and socio-cultural (libertarian/conservative) attitudes.

In turn, socio-economic and socio-cultural attitudes (demand) intersect to shape electoral politics (supply). Challenger parties increasingly mobilise the bottom quadrants.

This can be schematically mapped out in the following way:

 

Screen Shot 2018-09-24 at 17.31.15

Screen Shot 2018-09-24 at 17.48.22

 

Screen Shot 2018-09-24 at 17.49.39

Screen Shot 2018-09-24 at 17.49.47

R – Parties (1)R – Parties (2)R – Voters (1)R – Voters (2)

Lecture 5: Classical Political Economy

Introduction 

Last week we discussed the importance of economic and population growth in measuring the wealth of nations. We observed that there was a long period of stagnant economic growth from antiquity, and a limited improvement in aggregate living standards. The period from antiquity to 1700 is often referred to as the Malthusian era.

What we observed in the data was that it was only from the late 18th century, and the subsequent period of capitalist development from the 19th century onward, when economic growth really began to take off. What explains this divergence?

This was the fundamental question of ‘classical political economy‘.

Classical political economy is a term coined by Karl Marx in the first edition of Das Kapital, to describe those British economists that sought to explain the ‘internal framework [Zusammenhang]’ of the “bourgeoise mode of production”.

Classical political economy is a term usually associated with the normative defence of free markets (as opposed to state protectionism), and it’s origins are identified with the time period between 1750 and 1867.

Today, it is a term that primarily describes those group of political, moral and economic thinkers who drew upon and revised Adam Smith’s ‘An Inquiry Into the Nature and Causes of the Wealth of Nations‘. 

The objective of classical economic thinkers such as Thomas Malthus, David Ricardo, and John Stuart Mill was to analyze the production, distribution, and exchange of commodities in market societies.

But what really interested them was the impact of commerce on society; the role of the state in shaping the economy; and the emergence of industrial capitalism.

Put simply, they were interested in the politics of capitalist development, and the question why some countries are rich, and some countries poor?.

Adam Smith (and the division of labour):

Adam Smith’s Wealth of Nationspublished in 1776, opens with a discussion on the core concept that has shaped all theories of classical political economy: the division of labour.

For Smith, the division of labour explains the determinants of economic growth, as it is the key to productivity improvements in the process of capitalist development.

But what exactly does the division of labour mean?

  • It suggest that dividing the production process into different stages enables workers to focus on specialized tasks, which improves efficiency and enhances overall productivity. This, in turn, leads to technology improvements. In sociology, it is a concept that is used to describe the division of tasks in any given society.

One of Smith’s most popular examples to describe the division of labour is the manufacture of a pin. He describes each stage in the production process and shows that one person doing all 18 tasks can produce 20 pins a day, whereas if the 18 different tasks are divided among 18 different people they can produce over 300 pins a day.

For Smith, the most important outcome of the division of labour is skill specialisation.

The outcome of skill specialisation (which Smith describes as something that involves dexterity, tacit knowledge, skill and judgement) is a diversified economy, whereby each person is dependent upon the labour of another person.

In this context, everyone is compelled to co-operate freely in a process of exchange, as everyone is reciprocally dependent on everyone else.

This leads to his next observation:

The division of labour is wealth improving when the size of the market is bigger, and more diversified. Large markets increase the incentive to specialise.

Large markets, in turn, are made possible by “trust, reciprocity, good government, free trade and geography”.

It is often assumed that Adam Smith was a radical advocate of individual self-interest. But for Smith “man has constant occasion for the help of his brethren… he will most likely prevail if he can interest their self-love in his favour….it is by barter that we obtain from one another those mutual good office that we stand in need of“.

It is through individuals pursuing the satisfaction of human needs: food, clothing, hunger, which gives rise to commercial trade in a market society.

In summary: for Adam Smith, the wealth of a nations comes from the commercial expansion of markets, and productivity growth, which is dependent upon skill specialisation, and the division of labour.

Adam Smith (and the division of society):

Adam Smith’s labour theory of value led him to divide society into three different “classes” of person: landlords, wage-earners and capitalists.

Those who live by rent, those who live by wages and those who live by profits.

In Smith’s commercial society the hidden hand of the market acts a horizontal mechanism to ensure a diverse economy meets supply and demand. This horizontal market supplants a hierarchical model of society governed by elites.

Only productive labour, he argues, contributes to the wealth of nations. When citing unproductive labour he includes “politicians, poets, musicians, lawyers and economists”.

These are all necessary forms of labour but they are not wealth producing.

The hero of Smith’s tale of wealth accumulation (told in four historical stages) is the capitalist entrepreneur. Trade is considered more profitable than agriculture, even if the agricultural labourer is the most “virtuous of all persons” in craft and skill.

At the core of the human psyche for Smith, and classical political economy more generally, is need and desire (not rational optimal utility calculation associated with the marginal utility revolution of contemporary economics).

The desire to save and the desire to consume is what drives individual effort.

Free commercial trade, the division of labour and the expansion of markets is what enables this individual effort to come to fruition.

Contrary to popular conceptions of Adam Smith as the defender of vice and unfettered free markets he considers prudence the core virtue of capitalism.

For it is only through hard work and saving for the future that one can ensure the respect of their peers (sociability) and generate wealth (savings) for investment.

The role of the government, for Smith, is to get out of the way of commerce. But government in this context means protectionist, monarchic and authoritarian rule.

But Smith was also quite clear on what government (the sovereign) should do: provide security, infrastructure, administer justice and public education.

Adam Smith was under no illusion about the tradeoffs associated with commercial expansion, and capitalist development.

He states that commerce ultimately renders the merchant “deceitful”, whilst the idle landlord usually ends up “stupid”. If natural man is a “merchant”, then “the virtuous man is a farmer”.

Despite his romanticism for agriculture, he regularly points out that it cannot lead to aggregate wealth. A growth in national income depends on commercial expansion.

It is important to note that the Wealth of Nations is a historical and empirical text.

Smith examined both the historical predecessor to market society: feudal agrarianism, and the subsequent emergence of ‘mercantilism’.

Mercantilism was associated with state sponsored export-led growth and production (the promotion of exports over imports, and savings surpluses at expense of other nations).

Smith agreed with the French anti-mercantilist thinkers that mercantilism is consonant with absolutist rule, and a beggar thy neighbour strategy of commercial expansion.

Adam Smith (on self-love not selfishness):

For Smith, self-interest is the connecting force between ethical and economic conduct.

But self-interest is not to be confused with selfishness. It is better understood, in his words, as “self-love”, which is closely connected to reciprocity (exchange).

The term laissez-faire was never used by Smith. Further, he only ever used the term “hidden hand”, three times in his book.

For Smith, the expansion of commercial markets would ensure greater social and economic equality, which must be primarily understood as the dissolution of feudalism.

Finally, contrary to neoclassical economics, classical economic theory was built around the theory of labour value, and it’s impact on the material production of society (and the division of social classes: rentier, wage-earner and capitalist) that it gives rise to.

Remember Piketty’s core concern is that the rentier has replaced the capitalist in modern market economies. He’s arguing that the capitalist always becomes a rentier.

David Ricardo (on rent, profit and wages):

Building on the foundations laid by Smith, the classical political economists began to focus on the specialisation of the division of labor as the source of increasing wealth.

David Ricardo became interested in economic theory after readings Smith’s Wealth of Nations. In 1817, he published his famous Principles of Political Economy and Taxation.

The first line of the book states that the principal problem of political economy is that of sharing national income between rent, profit and wages (therefore he was interested in the distribution of income and not just it’s production or creation).

For Ricardo, the societal division between rent, wages and profit is the product of the commercial economic system; the volume of production within it, and the absolute income received by each person within the system.

In the late 18th century, national income was divided up between landlords, workers and capitalists. He takes this tripartite division of society directly from Adam Smith.

But unlike Smith he is deeply concerned with the rise and fall of real wages (what we would call purchasing power today) as a percentage share in national income.

He was concerned that too much of national income was being accrued in the form of rent to landowners.

As we will see Marx effectively borrowed, in total, Ricardo’s labour theory of value.

David Ricardo (and comparative advantage)

Ricardo is most famously known for his theory of comparative advantage.

This implies that a nation should specialise in the production of those industries in which it is most internationally competitive. It should then trade with other nations to import those products that it no longer specialises in at home. Swapping wine for bread.

Think about this today. What does Ireland specialise in? China? USA? France?

David Ricardo (on scarcity and rising rents)

But in his Principles (which is of most interest to us) he is primarily concerned with the long-term evolution of land prices and land rents.

His argument on scarcity and rising rents is as follows:

  • Once population and output grows, land becomes more scarce. The law of supply and demand suggests that the price of land will continuously increase (it will become scarce). This implies higher rents for landowners. Landowners will therefore claim a growing share of national income, at the expense of profit and wages.

In response to this, Ricardo called for a tax on land rents to control price increases.

His concern proved to be misplaced in the long term. Land prices increased but with the industrial revolution, the value of farm land declined relative to other forms of wealth in national income.

But his ‘scarcity principle’ is an important concept for understanding why certain prices might rise to very high levels over a given period of time (and the wealth accrued to those who benefit from rising asset prices).

Rising prices

To recognise the importance of prices, and how they are capable of destabilising entire societies and markets (and therefore benefiting certain economic interests over others), just replace the price of farmland in Ricardo’s model with the price of housing in Dublin, San Francisco or London today.

What is a reasonable price for a basic human need like housing?

Does this need to insure a reasonable price imply that the state should introduce price (rent) controls? Or is it something that should be left to the ‘market’? Should the state build houses, and therefore remove the profit motive for house building?

Adam Smith once wrote: “in times of necessity the people will break through all laws. In a famine they will break open the granaries and force the owners to sell at what they think is a reasonable price”.

In theory there should be a simple mechanism to avoid rent controls: the law of supply and demand. If the price of housing or rent in Dublin is too high, then demand should fall. People would rent property in those places where prices are lower. They would move to Donegal and commute. This is obviously not realistic.

As we will see in the coming weeks, one of Piketty’s core observations is that we should be concerned about the idle use of private wealth.

Hence, an obvious solution to the housing crisis might be a public investment project to build more houses. This means using taxpayers money, or borrowing on markets.

The general point is that Ricardo was trying to demonstrate that a long lasting divergence in the distribution of wealth is intimately linked to changes in certain relative prices, such as housing or land (the scarcity principle).

Thomas Malthus (and the diabolical trade off)

Thomas Malthus was also concerned about the scarcity of resources and how this might affect the distribution of wealth.

He published his famous essay on ‘Principles of Population‘ in 1798, and argued that the primary threat to society was overpopulation.

He based his observations on what was occurring in France, the most populous country in Europe at the time (20 million compared to 8 million in the UK).

The rapid population increases contributed to the stagnation of agricultural wages (more workers than jobs) and an increase in land rents (more people than land).

All of this fed into the growing unpopularity of the landed aristocracy, and fed the conditions that gave rise to the French revolution in 1789.

Malthus was concerned that the mass poverty, associated with rapid population increases, would ultimately lead to political revolution in England, where he favoured separate houses of parliament for aristocrats and commoners.

He was concerned it would end the rule of the elite.

For Malthus, as population increases, food per person decreases. He called this the law of diminishing returns. This meant that there is an inverse relation between wages and population growth. This is what some call the  ‘diabolical tradeoff’.

But there were natural adjustment mechanisms to deal with it: famine and war.

The Black death (1348-1350) was one of the largest determinants of population decline in history. In England, the Black Death wiped out 1.5 million people out of a population of 4 million.

In the absence of such natural adjustment mechanisms, Malthus called for an end to welfare assistance to the poor and proposed other mechanisms to reduce their reproduction habits.

Charles Dickens clearly disagreed with Mathus. His ‘Christmas Carol‘, published in 1843, can be read as an allegory against Malthusians.

If you remember, Scrooge repents in the end. There is no natural diabolical tradeoff between income and living standards/population increases.

But there might be a tradeoff about the rate of growth and the cost of public services i.e. people living longer cost the state more on pensions. Demographic changes put increased demand on public services, which raises the question: who pays?

This is a core fiscal problem that many European states are struggling to deal with today.

In fact, many argue that the crisis of contemporary capitalism is related to the crisis of fiscal democracy: public services require more investment, but everybody wants somebody else to pay.

Conclusion

Classical political economy is a term that is popularly used to describe a body of economic theory that advocates laissez faire, free market capitalism.

But it is more nuanced than this.

It is better understood as the beginning of a scholarly attempt to systematically analyze the emergence of commercial society, and the internal conflicts of capitalist development (particularly the determinant and destabilising effect of rising prices).

For the classical thinkers, the determinants of economic growth (and therefore increased living standards and the overall wealth of nations) is labour specialisation, human skill, productivity improvements, trade and the expansion of markets.

All of this was based on a particular political democratic theory of economic liberalism. Private property (against the state) was assumed to be the primary source of justice. Hence, it was what could be described as a normative political economy.

John Stuart Mill, for example, whom we have not discussed, favoured a different concept of private property. Markets provide an incentive mechanism to promote social utility.

Classical political economists assumed that greater social and economic equality would accompany the ever greater expansion of the market i.e. economic growth.

It was assumed more markets = more trade = more growth = rising tide lifts all boats. Whether this is true or not is what we will discuss on Weds.

The lecture slides can be download here. lecture-5

Lecture 4: What is economic growth?

Introduction

In rich countries individuals are healthier, live longer, have better access to public services and better educated. Why are some countries rich and some countries poor?

Why does this matter? Is economic growth coming to an end? What do economists mean when they talk about secular stagnation? Is economic growth always a good thing?

To explain these contemporary dynamics, and to answer some of these questions, it is worth taking a longer term perspective.

The first thing to note is that measuring “growth” requires examining both population and economic growth. It is the latter (better referred to as productivity growth) that tends to improve aggregate standards of living.

This data shows global economic growth since the industrial revolution.

The law of cumulative growth 

Albert-Einstein-8th-wonder

It is important to note that a small percentage change compounded over a long period of time accumulates very quickly. A generation of economic growth can spur huge social change. Just think about what Ireland looked like in the 1950’s, then compare it to the 1980’s. Now compare it to 2017. They are literally “generations” apart.

For example, an annual growth rate of 1 per cent is equivalent to a generational growth rate (30 years) of 35 per cent. An annual growth rate of 2.5 per cent is equivalent to a generational growth rate (30 years) of 110 per cent. For purely conceptual purposes, you can think of the latter as a 100% change over a generation.

In contemporary political discourse, politicians and policymakers often assume that a growth rate of 2 per cent per annum is small, and insufficient. But when compounded over 30 years, it can lead to a huge amount of socio-economic change.

Economic change can spur both positive innovation and social dislocation. But it can also create huge societal problems (i.e. housing stock not keeping apace with demand). Relying on the market is not necessarily good public policymaking.

Measuring compound change is called the law of cumulative growth.

When thinking about it in terms of wealth accumulation (as opposed to economic or population growth), it basically means that the annual rate of return (capital income) compounded over several years automatically results in a very large increase.

Hence, if wealth grows faster than wages, we tend to see a divergence in who benefits from economic growth.

  • Table 2.2 captures what this means in concrete terms and can be applied to anything from the rate of return on capital, population growth, household income or economic growth.

This is crucial for understanding Piketty’s argument on the inequality R>G.

A small gap between the aggregate economic growth rate (which gives a sense of wage growth) and the rate of return on capital (which gives a sense of wealth accumulation) can accumulate over many years, creating a deep structural divergence in society.

Most economists in the 20th century assumed that there would be a perpetual decline in wealth inequality, and assumed that economic growth would lift all boats (often called trickle down economics). Economic growth was considered something that equalised standards of living, as ultimately, in the end, everyone would benefit.

This is the normative foundation of democratic capitalism: everyone benefits, everyone gains, and not just the elite. Piketty is suggesting this is no longer the case.

Population growth

Let’s look at population growth for the moment, from antiquity to the present, to get a sense of just how much has changed over time.

  • Figure 2.2 depicts the growth rate of the population from year 0 to 2100. The demographic growth rate from year 0 to 1700 was less than 0.1 per cent. But in the end, much of this growth in the population was wiped out by famine and disease.

Population growth increased significantly with improvements in medical technology and sanitary conditions. Demographic growth accelerated significantly from 1700 onwards.

But there was huge variation between countries.

The USA went from a population of less than 3 million in 1780 to 300 million in 2010, whereas during the same time period, in France, it only doubled from 30 to 60 million.

According to UN forecasts the annual population growth rate will fall to 0.4 per cent in 2030 and then 0.1 per cent in the 2070’s.

This is not a course in demography, and we are not interested in demographic growth for its own sake. We are interested in population growth because it has implications for the structure of economic growth, and wealth and income distribution. As Piketty states:

Strong population growth, as in the USA, tends to play an equalizing role in wealth distribution. It decreases the importance of inherited wealth in the sense that every society must reinvent itself.

What does he mean by this? Put simply: if you are one of fifteen children, it is probably not a good idea to rely on inheritance from your parents to generate income and wealth.  Conversely, if you are one child, then you’re likely to benefit from inheritance.

The same logic applies on a population wide aggregate basis.

Economic growth

This observation (the equalizing role played by the law of accumulated growth) makes more sense when we extend it to economic growth. Ireland is a good example here.

If you live in a country that is growing rapidly, such as 4 per cent per annum (with wages growing 3 percent), over a generation (30 years), you would be wise to get working, to take advantage. Hence, inward migration to countries with growing economies.

Conversely, in a country with stagnant population and slow economic growth, and with poor employment and wage prospects, inherited wealth and capital accumulated from the past (i.e. from the hard work of your grandparents) takes on much more importance in society. Think about Italy.

This is why people emigrate to fast growing economies.

This is the crucial point for Piketty. The data suggests that western economies are slowing down rapidly but remain rich in wealth. They are capital-asset rich societies, with slowing productivity growth. Hence, the past impacts on the present.

Low growth economies are societies dominated by inherited wealth, and accumulated assets from the past (think Italy or France). Private capital that is owned tends to be saved and hoarded, rather than put to productive use in the real economy (i.e. investing in infrastructure). Think about an empty building in the city centre.

  • See table 2.5 for a breakdown of per capita economic output by global regional blocs.

Distribution

For Piketty, declining economic/productivity growth at the macro-level is the main factor leading to rising wealth inequality over the long-term (the inequality R>G).

Slow growth defined the 18th and 19th century. The fast growth in the 20th century changed this. Piketty suggests it has re-emerged today in the 21st century.

It is crucial to note that it was only during the 20th century that economic growth became a tangible benefit for everyone. Why? Access to health and education were central to this shared growth. The birth of the social state re-distributed growth to the benefit of society.

It was the birth and complement of liberal markets, and democratic welfare states.

In particular, the strong economic growth that swept Europe from 1945-1975 enhanced the possibility of social mobility for those whose parents did not belong to the elite of a previous generation. It also funded the emergence of the ‘social state’ in Europe.

The social state primarily refers to the brith of social rights: universal provision of education, healthcare, eldercare, and in some countries, childcare and social security.

In the post-war period of strong growth, new business models were created. New skills and capabilities were developed. Capital and labour were put to work in different ways.

Economics, however, tells us very little about the distribution of growth. This is a question of politics. Trade unions, for example, played a significant role in making sure the growth was compensated with a strong wage-productivity push, as pointed out by Larry Summers.

If societies want to ensure that the gains of productivity growth and technological innovation are distributed fairly (i.e. not captured through rents by the elite) then this requires an inclusive set of political institutions.

Democracy enables market capitalism because it widens the opportunity space for innovation and inclusion. See the work by Acemoglu and Robinson.

Discussion

What institutions and public policies are likely to lead to inclusive economic growth? Is it better to live under a dictatorship with a home and a job, than to be unemployment in a democracy?

It is this emphasis on democratic institutions, public policy and electoral choice that defines large parts of contemporary political economy.

Markets are viewed as variegated, and subject to radical mutations and adaptations (not a deterministic techno-economic paradigm), and primarily shaped by politics.

Conversely, Marxist economists anticipate a never ending crises of capitalism (such as the great recession) that will lead to its collapse.

But what about recent events? Does Piketty’s data suggest that perhaps Marx was partially right? Yes and no. We will discuss this next week.

Labour market

The major impact of technological growth in the 20th century has been in the structure of employment. The structure of economic growth has a huge impact on jobs.

  • See table 2.4 on changes to the labour market.

Over 70 per cent of the population in the western world now work in services; even in countries as diverse as France and the USA. This is a broad category and includes high-skill and low-skill service jobs, traded and non-traded.

The defining characteristic in all advanced capitalist economies of the western world  is the decline in manufacturing (and low to medium skills more broadly).

What we are witnessing is a growing divide between high and low skilled jobs, with medium skilled jobs (bank clerk, manufacturer etc) in decline. For economists, this is largely driven by the impact of globalisation, and technological change.

Think about the impact of technology on the labour market. For example, consider the impact of the Uber on taxi-drivers, robots on car manufacturing, computers on office clerks, washing machines on cleaners etc.

Here comes the bad news, most research would suggest that the structural shift from ‘manufacturing to services’ has significantly slowed down productivity growth rates, and that these are unlikely to increase in the near future.

Secular stagnation 

Most forecasts suggest that the thirty post-war years of strong economic and productivity growth in Europe were the exception rather than the norm.

The implication is that liberal democracies cannot rely on economic growth to realize their democratic aspirations. This has major implications for electoral politics.

Further, as we will discuss in later lectures, some economists suggest that the determinants of economic growth (technology and productivity improvements) may be in perpetual decline. This is often referred to as ‘secular stagnation‘.

Capital/wealth is running out of places to invest. It’s being hoarded/saved.

Since the 1990’s the policy response to low growth has been to remove the political constraints that inhibit free markets: liberalization, tax cuts, capital mobility, hard currency and austerity.

This is what popular commentators, such as Paul Mason, among others, call the crisis of neoliberalism.

The golden age

  • Figures 2.3 shows the comparative evolution of economic growth rates in Europe and North America.

Per capita output surpassed 4 per cent every year in most European countries between 1950-1970. If we exclude Britain it was even higher.

Now think about this in terms of the law of cumulative growth. This was the golden age of capitalism, it’s your parent and grandparents generation.

Note the difference between Europe and the USA from 1940-1975. This difference might explain why Americans do not have the same nostalgia for the ‘golden age of democratic capitalism’, or socialist democracy, as many Europeans do (again, think France).

UN and OECD data now suggests that Europe and the USA look set to enter a new period of low-growth.

Inflation 

Any discussion on the history of growth must, however, include an analysis of inflation. If growth is 3% per annum and inflation is 2% then we say real growth is 1%.

Between 1913 and 1940 inflation in Germany was 17% per annum. Prices rose by a factor of 300. Inflation was widely used to reduce the public debts accumulated during the world wars.

In 1720 England the average income was 30 pounds. Fifty years later, it was barely 40 pounds. Think about the average income in France today compared to the 1950’s.

The crucial point to remember is: monetary markers are stable when economic growth is slow.

Inflation is largely a 20th century phenomenon. It can be explained by distributional politics rather than economic science. See figure 2.6.

We will have more to say about this later in the course.

Conclusion

  • Figures 2.4 and 2.5 show that global growth over the past three centuries can be pictured as a bell curve with a very high peak.

Western economic growth peaked from 1940-1975 and then declined. With the ‘neoliberal’ revolution in the 1980’s growth picked up again in the 1990’s, and has since declined again.

As we will see, the period of liberalisation (post 1990’s) was made possible by FIAT money; new credit formation and the financialisation of debt.

The question many scholars are asking today, in the aftermath of the international financial crisis, and the subsequent “great recession”, is whether we will see a new paradigm shift in the architecture of our political economies?

If so, what will define the period of growth over then next 30 years? Will we see the emergence of a new economic paradigm? What will be the structure of economic growth? How will this impact upon the politics of economic inequality?

We have now mapped the history and explained the core concepts.

In the next lecture, I will discuss political economy theories on the determinants of capitalist development, before trying to explain why inequality has increased so rapidly since 1970.

The shortened lecture slides can be viewed here: Lecture 4