Lecture 20. Summary: The Political Economy of Inequality

Introduction 

In the rich market economies of the world, the incomes of the wealthiest are rising, whilst the incomes of the majority are stagnating. The outcome is growing wealth and income inequality.

None of this is in empirical dispute. What is in dispute is trying to explain why (i.e. the causal mechanism) and whether it is justified or not (normative legitimacy)?

Economic history

Piketty, and political economists more broadly, wants to put the issue of inequality into a broader historical context.

To do this, he traces the evolution of capital from the agrarian societies in the 18th century, through to the industrial revolutions of the 19th century, the inter war years, and into the second half of the 20th century.

There are three conclusions from this comparative historical analysis on the political economy of distribution:

  • Inequalities of wealth and income are influenced by a whole host of institutions; political, economic, cultural and normative factors (be sure to read the notes from lecture 19, which we did not have time to cover).
    • Piketty does not discuss the underlying determinants of national models of capitalism. This is where a comparative politics perspective becomes useful.
  • Markets when left to their own devices produce a high degree of inequality because the rate of return on capital always exceeds economic and income growth (R>G).
    • But not all markets are the same. There are multiple paths to economic and employment growth. The USA is, in many respects, an outlier.
  • On the basis of the inequality R>G, wealth tends to accumulate and concentrate at the very top of the income distribution.
    • This is a story about the rich , and the extent to which the top 1% of wealth owners have pulled away from the rest of society.

His core conclusion is that to tame the worst effects of market inequalities requires active fiscal intervention by the state, through a wealth tax.

Institutions 

It is important to note that democracies throughout the 20th century have pursued various public policy interventions to tame market inequalities: minimum wages, progressive taxation, capital controls, social security programs, collective bargaining rights, trade unions, rent controls and financial/banking regulations.

A central finding in the study of comparative political economy is that institutions – and their underlying political coalitions – actively shape market outcomes, and these institutions vary significantly between nation-states.

These institutions are usually associated with the functions of the labour market and/or the social state. But since the 1980’s, the political institutions that tended to create more egalitarian market outcomes have been gradually eroding (for a whole variety of reasons associated globalisation), with the implication that market inequalities within countries are increasing.

Markets

The benefits of globalisation have been defended for years by large parts of the economic profession and policymaking community.

Policymakers have tended to support and implement those policies that enable markets to get back to their competitive “natural tendencies”.

For critics, these natural competitive market tendencies logically lead to the inequality R>G, and undermine the meritocratic principles of democratic societies.

When competitive markets are left to their own devices, wealth accumulates and concentrates, with the implication that inheritance matters more than hard work.

This is the core normative critique underpinning Piketty.

It suggests that markets when left to their own devices leads to a “rentier” society not a meritocratic society. It suggests that a rising tide does not lift all votes (trickle down economics), and that the explicit hand of politics is needed to steer economies toward socially beneficial outcomes.

Wealth

Lets unpack the concept of wealth, which is used interchangeably with the concept of “capital” in the book.

The first question to ask is where does capital-wealth come from? There are two sources: inheritance and income (theft also matters).

Income can be broken down into two sources: income from labour (wages, bonuses and salaries) and income arising from owning capital (rent, assets, interest, bonds, stocks, dividends).

Wealth that accrues from either of these forms of income can be consumed, saved or invested. Most people barely earn enough income to cover their living expenses. They have no wealth.

Capital only becomes true wealth when it is not immediately consumed i.e. when it accumulates in a savings account, re-invested in financial stocks and bonds, owned in real and/or commercial estate, machinery, buildings or land.

Most capital-wealth is held in either housing or financial assets. The purpose of owning capital is to yield an income. This has not changed since the 19th century.

Capital/income ratio

Capital/wealth can be public and/or private.

In any given society, total wealth equals public+private capital (minus debt). In all market democracies today, capital is almost entirely privately owned.

For Piketty, the best way to analyze the importance of capital in a society (i.e. capitalism) is to measure the amount of wealth (stock) as it relates to income (flow).

Dividing the total capital stock by national income gives us the capital/income ratio (β).

Capital/income ratios are important because they provide us with a comparable quantitative measure to analyze capitalist development across time.

In most countries we find that, on average, national wealth is 6-7 times national income. The capital/income is 600-700%. We live in wealthy societies!

But capital/income ratios tell us very little about the actual distribution of capital in a society i.e. who owns the wealth at an individual or household level.

Most people own nothing at all. In the US and Europe, 50% of the population own less than 5% of the wealth. Wealth is more unequally distributed than labour-income.

The R>G inequality

Before Piketty analyses the precise distribution of income and wealth in Europe and the USA, he proposes a theoretical mechanism to analyze the evolution of capitalism:

  • When the rate of return on capital (r) is equal to economic and income growth (g) then the capital/income ratio remains stable.
  • When the rate of return on capital (r) exceeds economic growth (g) then the capital/income ratio grows. Wealth accumulates.

This is precisely what we observe in the USA and Europe since 1980. R>G leads to rising capital/income ratios. For Piketty, this suggests ‘private capital is back’.

On the basis of this historical analysis, Piketty finds that on average, in the long-run, economic growth averages 1-2%, whereas the rate of return on capital is 4-5%.

R>G is the logical outcome of what happens when markets are left to their own devices.

It was only during the fiscal revolutions associated with the birth of the social state in the 20th century did the inequality R>G go into reverse.

This was the period of an emergent property owning middle class, which was central to the politics of democratisation.

r>g

Theoretically, a high capital/income ratio does not imply a high degree of inequality.

All capital-wealth, in theory, could be distributed equally or held publicly. But this is not the case in a private market economy.

As we have seen throughout this course, in the USA the top decile own 72% of all wealth, whereas the bottom 50% own nothing.

Why does R>G lead to inequality?

But why does the mechanism R>G lead to increased concentration of wealth at the top of the income distribution? There are two reasons.

  • First, wage inequality. Most people only earn enough to cover their living costs. They cannot save or invest. The higher your wage-income the more more you can consume whilst investing and saving. The wealthiest (0.1%) tend to invest in financial assets. The capital-income from these assets tends to accumulate and reap a high yield/interest rate.
  • Second, inheritance. The largest fortunes in market economies are usually inherited not earned. Bill Gates is a very very rare phenomenon, and not representative of a general trend.

Why did inequality decline in the 20th century?

Capitalist markets generate high levels of inequality. This is not in dispute. But why then did we witness a rapid decline in wealth and income inequality from 1950 to the 1980’s?

  • In the 18th century most capital-wealth was agrarian. Large landowners owned 90% of all wealth in European societies. There was no such thing as progressive taxation. Most fortunes were associated with inherited land or government bonds. In this period, capital/income ratios were rising because of the inequality R>G.
  • In the 19th century capital was increasingly invested into industry not land. In Europe, most private capital was bound up with industrial assets and those foreign assets accrued through colonisation.
    • This was not the case in the USA. In this period, although the composition of capital change dramatically, the capital/income ratios continue to rise because of the inequality R>G. A rising tide did not lift all boats.
  • From 1914 through to the interwar years, private capital experienced massive external shocks. Capital/income ratios declined because of physical destruction, government debt, inflation, the introduction of top income taxes, rent control and a whole raft of capital regulations.
    • Post-war societies, in turn, gave birth to social democratic capitalism.
  • From WW2 until the 1980’s there was a balance between private and public capital (mixed market economies), which gave birth to qualitatively distinct national varieties of capitalism. This was the birth of the democratic state, where revenue and expenditure shifted toward providing income transfers (pensions and unemployment protection) and public services (healthcare and education) to all citizens. Labour and wages became more important than inheritance.
    • Trade unions and collective bargaining were strong, and reflected the structure of employment, and mass manufacturing.
  • In the 20th century economic growth exceeded or balanced capital-income growth. This was the period of a “rising tide lifting all boats”, associated with the Kuznets curve. Strong growth in a democracy gave rise to pressures for redistribution.

In summary, the decline in inequality took the shock of two world wars, followed by a revolution in the fiscal policies associated with the democratic state. In turn, this gave rise to national models of capitalism, based on distinct electoral politics.

There was nothing “natural” about this process of capitalist development and democratisation. It was the outcome of distributional “class” politics.

The rise of ‘neoliberalism’.

With rising economic and income growth, associated with the period of mass manufacturing/productivity growth, which made possible strong wage growth (and taxes), democratically elected governments could fund an expansion of social services, whilst implementing public policies aimed at re-shaping market inequalities.

These, in addition to macroeconomic polices aimed at full employment, meant that the quality of life for those lower down the income distribution rapidly improved.

  • From the 1980’s most countries were exposed to international financial globalization. There was a shift back to private capital, particularly financial capital. In response to the oil crisis, stagflation and overburdened welfare states, in a period of declining economic growth, the Keynesian demand management ‘consensus’ came to and end.
  • Public policies and institutions shifted toward “the market”, particularly in international capital markets. The middle classes, particularly in the US, did not continue to experience rising income. Economic growth slowed down, the structure of the labour market rapidly changed, whilst the capital incomes of those owning financial assets soared i.e. R>G.
  • The accumulation of capital-income ratios has meant inheritance has re-emerged as an important factor in determining who owns wealth, and who does not. Further, public opinion and has become much more tolerant of inequalities (probably because they are perceived as a just outcome of individual merit and talent).
    • It is also important to note what we covered in lectures 17-19, where we discussed the impact of globalisation on voter preferences, and the increase in electoral and parliamentary volatility. All of this has meant that it is much more difficult to build stable redistributive electoral coalitions.

This graph from Branko Milanovic is a useful summary of the story of financial globalisation over the past two decades:

winners-and-losers-jpeg

Distribution tables

Piketty uses distribution tables to track this historical change in wealth and income distribution from the 18th-21st century.

These are distinct measures from the Gini coefficient. T7.3

What these social tables suggest is that it is increasingly important to observe those changes in the top decile and top centile of the income distribution, as this is where most of the radical changes in the politics of distribution have taken place.

Most of the income and wealth gains since 1980 have accrued to the top 0.1 percent of the population. This trend has increased, not decreased, in the aftermath of the crisis!

Why does this matter?

Piketty does not get into a normative discussion on questions of fairness or social justice. This is perhaps a major problem of the book. Why should policymakers car?

He basically argues that even if you think extreme inequalities are justified, it is hard to legitimate a situation where inheritance matters more than merit.

He also warns us about the dangers to democracy in a society completely dominated by private capital, particularly when the top 1 percent.

He also highlights the distributive implications (and irony) of austerity and public debt in European societies rich in private wealth.

His solution to stem the rise of economic inequality, and to avoid the worst effects of R>G, is to impose a coordinated and progressive global wealth tax (including corporate profit).

Conclusion

The conditions under which a coordinated wealth-capital tax is possible is a question for political science. It requires international cooperation to overcome collective action problems.

The most likely place it could occur is in the EU. But such cooperation is undermined by growing tax competition between nation-states.

This capital tax should be used, according to Piketty, to pay off the public debt of those sovereign states who stepped in to save the financial sector from collapse.

He also argues that it should be used to raise revenue to invest in education and public infrastructure.

In the absence of international cooperation to regulate global capital in the 21st century Piketty anticipates a rise in support for nationalist, right wing, and anti-european political parties.

This brings us to the end of our lecture series. Best of luck in the exams, and the rest of your studies. At least in university, the price of success is hard work!

Slides: Lecture 20

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Lecture 19: The Politics of Comparative Capitalism (3)

Introduction 

The socio-economic structure, and underlying political coalitions, that defined the growth of the social state in the 1970’s, has profoundly changed.

But the predictive power of occupational class on voter choice remains strong.

The post-industrial coalition is predominantly anchored in the middle class, which tends to prefer social investment policies over traditional social protection policies

This has had an important impact on the trajectory of the welfare state.

Remember the importance of “interests, institutions and ideas” in shaping the politics of advanced capitalism today.

Whilst political coalitions shape public policy choices, these choices become institutionalised over time.

Institutions 

These institutionalised policy choices evolve into distinct “national models of capitalism”, or “worlds of welfare”.

Institutions reflect the dominant political interests that shaped the origins of the institutions.

Over time, these become “sticky” and “path dependent”, and shape the politics of adjustment, when countries are confronted with the need to reform.

Liberal market economies

Different countries tend to cluster together in terms of their labour market, social policies and capital markets institutions. This gives rise to “ideal types”.

LME’s “typically” have the following characteristics:

  • Deregulated financial-capital markets (venture capital)
  • Flexible and decentralised labour markets (high/low wages)
  • High levels of income inequality (weak trade unions)
  • Means tested and minimalist welfare state (lower taxes and small public sector)
  • Competitive market institutions (high tech exports and global firms)

Countries that fall into this cluster: UK, USA, Australia, New Zealand, Ireland.

Coordinated market economies

CME’s “typically” have the following characteristics:

  • Bank based capital-markets (patient capital)
  • Coordinated and sectoral-based labour markets (dualised protection)
  • Medium levels of income inequality (sectoral based trade unions)
  • Social insurance based welfare states (Bismarckian employer oriented)
  • Coordinated market institutions (medium tech exports and sectoral specialists)

Countries that fall into this cluster: Germany, Japan, Austria, (France, Italy and Spain in some models. But these are also distinct), Belgium.

Social market economies

SME’s “typically” have the following characteristics:

  • Deregulated capital and financial markets (small open economies)
  • Flexicurity based labour markets (secure the person, not the job)
  • Low levels of income inequality (encompassing trade unions)
  • Universal based welfare states (high taxes and large public sector)
  • Competitive market institutions (high-tech exports)

Countries that fall into this cluster: Nordic countries in Scandinavia, particularly Denmark and Sweden, but also Switzerland and the Netherlands

Power resource theory

What gave rise to these national models of capitalism?

The most influential theory is the “power resource” theory. This gives priority to the extent and type of “working class” organisation in the 20th century.

In countries where Social Democratic political parties prevailed, and where trade unions were encompassing, SMEs tended to get institutionalised.

In countries where Christian Democratic political parties prevailed, and where trade unions were sectorally specific, CMEs tended to get institutionalised.

But what about LMEs? What explains the USA and the UK development?

Convergence/divergence

Are all national models of capitalism converging on the LME model?

Most research would suggest that what we are observing are different trajectories of liberalisation. Countries adjust and liberalise in different ways.

Explaining these paths of adjustment is central to the study of comparative political science research.

The path of adjustment is shaped by electoral politics and domestic institutions.

It’s not easy for an LME to become an SME. Path dependence matters.

Conclusion 

Globalisation has fundamentally re-shaped the socio-structural landscape of advanced market economies.

This can be directly observed in the changing occupational structure of jobs, and rising wealth and income inequality.

These changes, in turn, have impacted the socio-economic and socio-cultural preference of workers and voters, in different ways.

But the path of adjustment varies according to national models of capitalism, which are built around qualitatively distinct political and economic institutions.

Change is constant, but it is not the same anywhere.

Lecture 18: The Politics of Comparative Capitalism (2)

Introduction 

Last week, we discussed the socio-structural impact of globalisation on the labour market in the advanced capitalist economies of the western world.

  • Rise of the service sector
  • Occupational upgrading  
  • Job polarisation
  • Feminisation of the workforce

We concluded that this is leading to new socio-economic and socio-cultural preferences, which is reshaping the comparative politics of advanced capitalism.

On the basis of these occupational changes, I suggested that what we are observing is the rise of four different socio-class groups, with distinct preferences.

  • Business-finance professionals (often in ICT/legal accountancy/finance)
  • Socio-cultural professional (often in health care/educational services)
  • Small/medium sized firms (often in construction/farming)
  • Precariat (often in domestic private services such as retail/food/leisure)

These groups are affected by globalisation (liberalised trade, free movement of peoples, capital, goods and services), in very different ways.

Supply/demand of politics

Political economy research suggests that different occupational groups are “threatened” by the liberalisation of trade, and immigration, in different ways.

This means they will want different types of public policies from government.

If you have data on the following, you can predict a lot about voter behaviour:

  • Age
  • Income
  • Skill level (proxied by educational attainment)
  • Occupation

It is this intersection between education and occupation that shapes social class.

Socio-cultural

Political economists use a variety of indicators to analyse the socio-cultural preference and attitudes of voters, and how these are impacted by liberalisation.

These are usually captured by measuring people’s attitudes toward:

  • Immigration
  • European integration
  • Family values

Older voters, with median levels of income, but relatively low levels of educational attainment (petite bourgeoisie), usually have more conservative-nationalist values.

Socio-economic

Political economists use a variety of indicators to analyse the socio-economic preference and attitudes of voters, and how they are impacted by liberalisation.

These are usually captured by attitudes toward the state-market relationship:

  • Taxation
  • Expenditure

Business-finance professionals, with relatively high incomes, and high educational attainment, usually have a preference for less taxation.

Political economy research would suggest that socio-economic and socio-cultural attitudes intersect to produce the following preferences toward public policy:

https://drive.google.com/open?id=0B8XXih2ReeuKUzdEbmJFd012Q0ZkTlRhWWstalNnbmhLRTVz

Hence, the impact of globalisation on voter behaviour – and what type of market economy citizens want instituted (type of capitalism) – is far more complex than a simple preference for “left wing” and/or “right wing” public policies.

These intersections go some way to explaining the rise of the nationalist right.

Attitudes toward the welfare state

This becomes even more complex when we split the socio-economic variable (more/less tax) into two dimensions (type of tax, and type of expenditure).

Different socio-economic groups (the four quadrants earlier) want the government to spend their taxes (public expenditure) on very different things.

  • Social protection (social welfare state)
  • Social investment (social investment state)

Higher income voters, paying higher taxes, regardless of their preference toward taxation, generally want government to prioritise social investment, not welfare.

These different attitudes toward the “welfare state” increasingly overlap with attitudes toward immigration, leading to “welfare chauvinism”. Think Brexit.

Low-to-middle income working class voters, with relatively conservative-nationalist attitudes, and who are more threatened by liberalisation of trade/immigration, also tend to have increasingly negative attitudes toward the welfare state.

The implication is as follows:

https://drive.google.com/open?id=0B8XXih2ReeuKSWw0VlBsNDBjZ0l5alhVbEtjQ2NrSV9BVDln

Realignment of western party systems

It’s for all of these reasons that the political landscape in the advanced capitalist economies of the western world have become much more fragmented:

  • Higher parliamentary volatility
  • More political parties
  • Rise of left-libertarian parties
  • Rise of right-authoritarian parties

The political parties that have suffered the most from the socio-structural changes brought about by global liberalisation are centre-left, social democratic parties.

The parties that have benefited the most, tend to be on the political right. Why?

In response to the changing demands of the electorate, political parties will increasingly target their policies at building different electoral coalitions.

Think about this concretely in the Irish case. It gives rise to the following coalitional possibilities, which in turn, shapes the type of public policies pursued:

https://drive.google.com/open?id=0B8XXih2ReeuKX29jdTlXeFp6SHAxb1d4dHpweEZURzhBVFZZ

Note that the volume effect of jobs/voters will always be in the bottom two quadrants. No political party can form a government by only targeting one group.

In terms of tax/spend policies (fiscal policies, which are central to the social contract governing the relationship between citizens and state), the supply/demand of politics would suggest the following coalitional possibilities:

https://drive.google.com/open?id=0B8XXih2ReeuKckxISmNlVmthY3JUUkF5Q0ItdlI1S0NjdjJz

In Western Europe, research suggests that Left parties have lost political support among the traditional working class (bottom left quadrant), but have expanded their support among the professional middle class (top left quadrant).

This is often described as the “middle-class shift” in comparative politics.

Ireland

Ireland is qualitatively distinct from the rest of Western Europe in that it has not witnessed the rise of a populist authoritarian right-party.

This is partially explained by the fact that on the “supply” side of politics, it’s a left-nationalist party (SF) mobilises voters in the bottom right/left quadrants.

Ireland is also qualitatively distinct in that it never had a clear left/right divide within parliament (again, this is on the “supply” side of politics).

Ireland’s welfare state was constructed by a popular centre-right nationalist party (FF), and not a Christian Democratic, or Social Democratic party.

Conclusion

Why does this matter? For scholars of power resource theory, in particular Esping-Andersen (Three Worlds of Welfare Capitalism), the electoral foundations of working-class power were crucial to the longevity of the welfare state. This has been transformed by social change.

But despite the decline in what was traditionally called the “working class vote”, the welfare state remains in place, and it remains stable. Next week we will discuss why this is the case, with reference to the path dependent and historical effect of institutions.

The decline in working-class support for left parties has been replaced by a pro-welfare move by right-wing parties, but also partly from a leftward move among middle class voters.

The result is shifting welfare state coalitions that look quite different from those of the past.

Lecture 17: The Politics of Comparative Capitalism (1)

Introduction 

Why are some countries more unequal than others? This is a question that Piketty does not consider, and does not answer. But it’s central to the study of political science.

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

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

The supply and demand of politics

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

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

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

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

Globalisation and labour market change 

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

This is often just referred to as “globalisation”.

In advanced capitalist societies, there are four distinct trends:

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

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

The political economy of the service transition

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

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

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

Occupational upgrading and job polarisation 

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

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

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

Feminisation of the workforce

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

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

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

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

Conclusion

Why does this matter?

See: https://drive.google.com/file/d/0B8XXih2ReeuKUzdEbmJFd012Q0ZkTlRhWWstalNnbmhLRTVz/view

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

Lecture 17

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

Introduction

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

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

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

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

Market competition or social rights?

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

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

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

Post-financial crisis 

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

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

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

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

The fiscal state

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

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

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

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

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

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

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

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

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

The social state

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

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

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

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

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

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

Social rights

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

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

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

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

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

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

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

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

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

Modern redistribution

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

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

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

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

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

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

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

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

Conclusion

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

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

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

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

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

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

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

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

Discussion

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

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

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

Lecture slides: lecture-16

Lecture 15: The future of global wealth inequality

Introduction

Should democratic societies be concerned about wealth concentration?

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

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

Figure 11.11 illustrates why Piketty is concerned about inheritance.

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

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

Inheritance 

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

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

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

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

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

What is Piketty getting at here? 

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

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

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

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

Global inequality 

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

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

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

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

It suggests that there are two worlds at the top.

Global wealth

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

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

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

Is this compatible with democracy?

Global tax

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

Hence his proposal for a global wealth tax.

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

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

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

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

Money reproduces itself.

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

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

To quote him directly:

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

University endowments 

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

Table 12.2 reports the findings.

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

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

They tend not to invest in US government bonds.

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

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

Sovereign wealth funds 

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

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

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

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

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

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

Petro states

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

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

Their populations are often tiny but their investments are huge.

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

China

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

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

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

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

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

Conclusion

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

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

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

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

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

Is this feasible?

Discussion 

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

The slides:lecture-15

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

Introduction 

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

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

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

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

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

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

Revision

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

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

capital-ownership

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

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

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

France 

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

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

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

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

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

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

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

Britain and Sweden 

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

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

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

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

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

Nothing went to the poorest half of the population.

USA

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

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

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

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

Europe/USA

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

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

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

The Mechanism of Divergence: R>G

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

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

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

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

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

Why?

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

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

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

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

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

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

Taxes and growth

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

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

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

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

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

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

The social state

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

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

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

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

The role of politics 

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

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

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

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

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

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

Impact of war

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

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

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

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

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

Taxation 

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

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

Up until WW1 there was no tax on corporate profits.

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

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

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

Conclusion

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

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

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

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

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

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

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

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

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

Slides: Lecture 14

Lecture 13: Explaining Rising Inequality; Winner Takes All Politics?

Introduction

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

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

Most economic explanations tend to emphasise apolitical processes of economic change: education, skills and technology. These certainly matter in the long run. Education and technology are perhaps the most important long term drivers of productivity improvements.

But most economic accounts of technological change cannot explain:

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

Winner takes all politics

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

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

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

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

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

  • Financial markets
  • Corporate governance
  • Workplace relations
  • Taxation

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

National models of capitalism 

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

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

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

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

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

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

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

So, ask yourself: Can different levels of education and skill  explain this outcome?

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

Compatibility with democracy

Is this extreme rise in economic inequality compatible with democracy?

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

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

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

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

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

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

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

Politics as a form of organised combat 

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

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

Drift is the cheapest way to abandon the median voter.

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

Why?

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

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

Declining mass membership

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

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

unions

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

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

Winner takes all

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

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

Conclusion

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

This is what we call the study political economy.

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

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

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

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

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

Lecture slides: Lecture 13

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

Introduction

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

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

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

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

The reduction of inequality in France

Four observations stand out from this data:

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

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

Piketty suggests that war rather than democratic rationality erased the past and allowed European countries to begin anew.

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 progressively more important.

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

A manager on an income of $5,000 per month might rent out an apartment at $1,000 per month, and/or hold shares in his/her firm. This is a monthly income of $6,000. 80% of his/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: 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, therefore, probably completed 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.

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.

This political effect this had on the labour market led to a significant compression of wage inequalities.

The turn toward fiscal austerity and wage competitiveness from the 1980’s, particularly under Mitterand, meant that this compression was reversed. Wages were frozen and profits increased.

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 where 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 financial crisis of 2008?

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 debt.

This debt was repackaged and recycled into complex and increasingly uncertain financial markets.

Larger share of the pie

From 1977-2007 (the eve of the crisis), the richest 10 percent appropriated 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 is for a company that doesn’t even make money!

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.

Next week we will examine the role of politics and institutions in explaining the cross-national variation in different models of capitalism in Europe and the USA.

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