Inequality is about capital vs labour

I was in a seminar recently where the presenter explored some trends in income inequality in Australia, Canada and the US over the past century.  While there was much to like about economists trying to unravel this issue, including the repeated reminders that representative agent models cannot deal with this problem, I had some niggling doubts that the whole story was being considered. I thought this presenter was sticking to only the issues deemed acceptable to discuss in the economics community, while ignoring the more important political issues.

First the good parts. Education is not a solution to income inequality. Canada and the US in particular are very highly educated countries, whose average educational attainments have soared for the past 30 years – the exact period that also saw huge growth in inequality.

It was acknowledged that the greater the degree of inequality, the easier it is to buy favours within political processes, further entrenching the income divide. It was nice to see economists raise these political points, but equally it highlighted how much of a disgrace it is that economists (and economic theory) play such a key role in capturing political processes for the 1%. 

Now to the issue I believe is the crux of the income equality debate.

I was informed in the presentation that the inequality story of the past 20 years is not about the division of income between capital and labour. Labour incomes in the top 1% are increasing very rapidly too. Sure. But we know that CEO and executive pay is more closely linked to capital returns than ever before, following the broad acceptance of the principle of incentive pay and aligning executive pay to share market performance.

When I look at the data from the Henry tax review, I find that in fact that the distribution of income from capital is far more distorted towards the upper end than income alone.

I have borrowed the chart below from the Henry Review website. What we see is that the top 5% of income earners in Australia get half of total national income from owning capital assets. While they only get 15% of the wages. 

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We can even see that the bottom 20% are making capital losses (capital gains and dividends), highlighting the process by which the poor are becoming more dependent on labour income.

Many researchers do in fact note that decreasing labour share, and therefore increasing capital share, of national income has been a global trend since the 1970s. What few say however is that this is trend is a result of policy choices informed by neoliberal ideology. We certainly could have avoided this trend if we desired. It was simply a matter of different policy choices. And to reverse the trend is also very simple, should be desire to do so.

In a mere technical sense, reversing the trend couldn’t be easier. Off hand I can think of dozens of policies; from inheritance taxes, greater public transparency of personal income data (including trusts), land taxes, improving the power of shareholders in the determination of executive pay, grants of land or capital for public service, and more. The options are limitless.

The barrier to change is modern realpolitik. Those at the top have captured the political process, partly by capturing the media. Any change will entail a massive redistribution of wealth from those who bankroll the political parties, to those with the least resources, the least education and the least interest.

This is the heart of the matter, and one we repeatedly avoid discussing.

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Comments

  1. ‘Any change will entail a massive redistribution of wealth from those who bankroll the political parties, to those with the least resources, the least education and the least interest.’

    It’s a biggie, but…Why?

      • Like me, Rumples is appalled by the sheer economic inefficiency of the whole economic set up.

        We have deadweight costs of ~5% of GDP PLUS all those stupid Tax Expenditures – just so some privileged group or another can avoid paying tax.

        Improving the lot of the poorest has profound implications. If they have a little more money they do odd things like get their teeth fixed, feed their kids better and lift their eyes from drudgery. But no, 2D, you are employed to prevent such wholesomeness. A docile dutiful workforce in fear of losing a scarce wage is the agenda.

      • “Improving the lot of the poorest has profound implications. If they have a little more money they do odd things like get their teeth fixed, feed their kids better and lift their eyes from drudgery.”

        I agree, but then I believe poverty is caused by a complex range of different economic and social forces. Others seem to think poverty is just a matter of choice and laziness. How they can ignore economic reality is beyond me, but they do. The same people must believe the official unemployment figures are a true reflection of unemployment!

        Anyway, to them better health outcomes for the poor just means the poor live longer (and stay a burden for longer) and have more children. I suspect many must secretly bemoan the discrediting of eugenics, but I doubt too many would admit to it.

  2. What I want to know, is how much “income from capital” is from zero-sum economic rent and how much is from actual newly created wealth.

    We need to focus on eliminating the former and maximising the latter, not on mindless “wealth redistribution” after the fact.

    Henry George was clear about this, which is why he advocated land taxes, because land is one of the sources of zero-sum rent gains. He also lamented the stupidity of the political representatives of “labour” in constantly attacking the employer class, when the real threat was the rentier class. Employers and labour are actually sitting on the same tree branch; if it is cut off to spite the employer, labour goes down with it too.

    • I furthermore want to make a distinction between types of economic rent in land.

      We seem to have completely forgotten that economists in the classical era were not merely talking about “economic rent” in land as it exists today – which is merely a matter of premiums for location efficiency and transport cost savings. People are NOT having to out-bid each other to get a share of a basic and supply-limited necessity. Food and natural fibres and timber and so on is sold on a “cost plus” basis in competitive markets and there is no “economic rent” embodied in the price at all – just a cost of transport which is so low that it is all netted out anyway into a “one sale price for everywhere” by the major distributors.

      There used to be economic rent in everything produced on the land, because primitive transport systems meant that the supply of everything was indeed only what land immediately adjacent to the city could produce. This meant that as incomes rose and people bidded against each other for, say, the available supply of milk, the owners of milk-producing land got richer while everyone else went forwards one step and backwards one step. And some proportion of the population would be unable to afford milk at all. Hence Karl Marx calling for nationalisation of land and Henry George calling for land value taxation.

      Economic rent of this magnitude was eliminated by transport systems becoming so advanced that the cost of transportation even right round the world almost ceased to matter as a proportion of the cost of familiar commodities. This has led to “cost plus” pricing, in competitive markets, for just about everything.

      The cost of commuting by car is similarly low enough that as long as there are no UGB’s or proxies for them, there need be no economic rent in urban land apart from “location” premiums. This is really like “positive sum” rent because it represents actual cost savings. “Negative sum” rent is someone getting to gouge “the maximum that people are prepared to pay for a necessity” over and above what the price should be if there were not restrictions on the supply of the necessity.

    • Agree something doesn’t add up with the labour/capital share of GDP. Since the dot com crash and even earlier (going back to mid 80’s), capital investment in developed countries has been shrinking as a share of GDP. So the expected return to capital cannot be as high has the labour/capital ratio implies.

  3. I have borrowed the chart below from the Henry Review website. What we see is that the top 5% of income earners in Australia get half of total national income from owning capital assets. While they only get 15% of the wages.

    And I expect that statistic is also wildly skewed by the top 1%.

    From memory, $150k-ish puts you into the top 5%. This is a reasonably easily attainable salary for someone in the right fields (IT, Engineering, Medicine) by their mid- late-30s, often without even having to make the jump into management. I doubt many of the people in the top 98-99% are making any serious amount of their income from capital assets.

  4. Great post.

    Another thought. Let’s get rid of the dredded NAIRU. Full employment should be a national goal. A slack labour market is Capitals best friend.

      • Most capital is the rentier.

        Owning digits in a bank does nothing for society. Buying pre-existing shares from another shareholder does nothing for society.

        Profit share of GDP has increased at the same pace as labour share of GDP has declined. All started from the 1980’s when the NAIRU was first introduced.

        Coincidence?

        Business loves a weak labour market. That is why the Right are obsessed with wage inflation. But we never hear much about “profit” inflation. Curious.

  5. I agree NAIRU does not help the entrepreneur – but that is different to capital.

    The entrpreneur is not interested in weak wages – he/she is interested in demand. Demand comes from people earning good wages.

    Established businesses (Walmart, McDonalds etc) who are the major employers, benefit greatly from NAIRU.

    • Aggregate demand increases in the long run only come from increased production of goods and services in which there is utility that people are prepared to pay for. Merely increasing wages does not increase aggregate demand if the production of goods and services remains unchanged.

      And to the extent that someone, somewhere, succeeds in getting a little more share of the produced goods and services for NOTHING (because they have succeeded in making an incremental gain in zero sum rents they gouge out of the system), this will actually REDUCE the rate of increase in production of goods and services in which there is utility that people are prepared to pay for, leaving everyone other than the successful rent-seekers worse off.

      Economic rent is like a bypass valve in the connection between real production and aggregate demand. It increases “aggregate demand” without increasing production, and imposes a cost on producers, constraining their ability to produce and to provide their own actual labour forces with the income that SHOULD be matching “aggregate demand”.

      This is like a closed feedback loop that has to be a cause of economic catastrophe regardless of how long the seeming illusion of perpetual motion is maintained.

  6. “Education is not a solution to income inequality. Canada and the US in particular are very highly educated countries, whose average educational attainments have soared for the past 30 years – the exact period that also saw huge growth in inequality.”

    I think there is some confusion here between real education and degree sale. Obtaining a degree is not the same as getting educated. Although there are more people with degree, there are less and less educated people – education turned into very profitable business in last couple of decades and that increased inequality by introducing new additional wealth transfer system. Poor people now have to go into big debt to get almost worthless degrees. in USA for example, an average student debt balance is $25k (not much different here or in Canada). Median household wealth is around $70k.

    $25k + interest spend on mostly worthless degrees over the time may reduce household wealth by 40%

    On the other hand, I will argue that real education is the solution. In a democracy, educated majority would quickly solve rising inequality problem by removing unfair advantages to the rich people.

    That must be one of the reasons why ruling class turned education into marketing based “thin air” sale business.

  7. I would only disagree with one statement. Where you said “partly by capturing the media”. I would amend that to “wholly”.
    Imagine a world where the media spells out a specific manifesto (a proper use of polls would be key to the creation of such). Political parties have to publish their response to the issues and their intended solution before an election. No ducking, no weaving….
    Of course, the focus is now transferred on to the question “who ultimately edits the list of issues and the net responses?”. However difficult the process of ensuring a representational list of issues and mean responses, it’s childs play compared to getting a result from the unstructured, factional, ego-driven, rent seeking prone process we have right now.

  8. [In Canada nd the US,] average educational attainments have soared for the past 30 years – the exact period that also saw huge growth in inequality

    Yes, average attainment has soared, but has attainment inequality been reduced? If the wealthy improve their attainment, the average may soar but it is exacerbating inequality rather than improving it. I would posit that education equality is a likely source of future income equality. Breunig does not address this very well and when he does, he uses highly spurious analogies. Take his concert ticket analogy for example:

    In many ways, capturing high-paying jobs is a lot like capturing one of the tickets to a very popular concert. If you camp out for five days, you will capture one of the tickets. But if everyone camps out for five days, that does not mean they will all get tickets. There are only so many tickets to be captured and there are only so many high-paying jobs to be captured.

    He neglects to address the closest match of that situation to our current education system. Imagine that 25% of people camp out for tickets and the other 75% do not. It is guaranteed that all of the tickets will go to those in the 25% that camp out. In the same way, if only the wealthy are highly educated you can virtually guarantee that the vast majority of high paying jobs will go to those that are already wealthy. It is only by “camping out” that the poor have any chance of getting into the party.

    • Exactly, see the Charles Murray items I link to in a comment above. It is pointless educating twice as many people in law, as the number of lawyers we actually need.

      Meanwhile someone who got into a trade and got good at it and started their own small business, is far better off than if they had gone to Uni and got a qualification in a profession that is saturated with graduates.

      This from TownHall’s Kurt Schlichter is very cutting:

      “……It breaks my heart to see the young lawyers I hire hobbled by six figures of debt. But hey, your desperation works fine for us established folks. I got 297 applications for a junior associate position. Let me say that again – 297. Most of them weren’t even practicing law – they were brewing coffee, not writing briefs. Now, I understand that most of you learned nothing but liberal clichés in college, but take a guess: As an employer, are the salaries I pay generally more or less when I have 297 people competing for each job?……”

      http://townhall.com/columnists/kurtschlichter/2013/11/04/maybe-pain-will-teach-you-millenials-not-to-vote-for-your-own-serfdom-n1733722/page/full

  9. I like what your saying Rumples, I’ve struggled to understand how the current insanity of Sydney RE prices can be not merely maintained but rather accelerated and the sticking point is always that our gen X,Y,Zers are skint . Putting a little more money in their pockets is the perfect way to ignite their animal spirits and get their attention focused where it needs to be If we just keep doubling Sydney RE prices we can all be very wealthy literally every Bogan will be a millionaire.

    Seriously, the solution is to once again open our society so that individuals entrepreneurial spirits are ignited, so that opportunities can be acted upon. I find that average Aussies go through life with a glass-half-empty attitude, if questioned they honestly believe they cant do something, It’s somewhat amusing is to watch them try to find someone (some regulation) that constrains the activity that they’d seek to exploit.

    I think the most important thing this government can do is to put an end to the land supply constraints that underpin our RE ponzi scheme. Do this one thing and Investment can once again become something that requires positive cash flow, Individuals will be forced to look once again at themselves and ask themselves What can I do? How can I invest in my own future?

  10. Rumplestatskin,

    I said it, but I would like to repeat it every time you write something so meaningful:

    You are a really brave and rarely intelligent young man and I wish Australia would have had more of your kind.

    Keep up the deeper digging and you will be enlightened by the truth. Good job, young man!