GV4D4 - week 3

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These are my notes from October 10 for GV4D4 at the London School of Economics for the 2017-2018 school year. I took this module as part of the one-year Inequalities and Social Science MSc program.

The usual disclaimer: all notes are my personal impressions and do not necessarily reflect the view of the lecturer.

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Inequality and Redistribution in the Rich Democracies

Readings

Capital in the Twenty-First Century by Thomas Piketty (chapters 7-11)

Chapter 7

• addresses the mistaken concept that growth favours labour over inheritance (spoiler: it usually doesn’t)
• in 19th century France, labour alone (no matter your profession) was rarely enough to compete with inherited wealth
• in the US it was different (inherited wealth mattered little) until the 20th, especially due to the slave trade and all the compounding consequences of that
• it’s important to distinguish between income/wealth inequality for labour, and that for capital, because the moral justifications are different
  • and the econ/socio/political mechanisms are different
  • for labour: market, education, rules and institutions
  • for capital: inheritance laws, savings and investment behaviour, real estate and financial markets
• income inequality for capital is always more unequal than for labour
  • but this is due to political institutions and norms, not nature
• the 20th century saw a huge structural transformation in the distribution of wealth in developed countries
  • growth of a patrimonial (propertied) middle class)
  • coincided with a falling share of wealth held by the upper class
• prediction: by 2030, top decile in US will have 60% of NI
• now let’s look at justifications of high inequality:
  • in a hyperpatrimonial society (with lots of rentiers), inherited wealth plays a huge role and has a tendency to become very concentrated
  • this describes Belle Époque Europe (1871-1914) and the Ancien Régime (pre-revolution France)
  • contemporary society is more “hypermeritocratic”, esp in the US (and dw, Piketty is well aware that “meritocracies” are smokescreens used for justifying unjustifiable distributions of wealth/opportunity)—inequality is primarily due to a class of “supermanagers” with high labour income
  • ofc, the two models can coexist; the children of supermanagers/superstars can become rentiers

Chapter 8

• fall of inequality in France in 20th century due to the fall of the rentier (top incomes from capital fell dramatically)
  • the top centile has gone from rentiers to managers (from capital to labour)
  • in other words, rentiers fell behind managers … which didn’t necessarily make things better for the people at the bottom
  • income from capital usually due to financial assets in upper decile (stocks, shares, etc)
  • though ofc this all comes from tax data—obvious risk of underreporting
• May 1968 France: cultural, political upheaval that changed everything
  • soon, minimum wage increased by 20%
  • 1970s: min wage indexed to mean wage and was boosted almost every year after
  • 1980s: inequality rises again, due to top salaries of exec salaries
• US: more egalitarian at start of 20th but now obviously worse (but in a way that is structurally different from the 1900s)
  • the financial crisis will not stop the structural increase of inequality—slower gains in capital income will not reverse the trend
  • obvious link between rising inequality in the US and financial instability (households turned to credit to finance their lives)
  • between 1977-2007, the top 10% took 75% of the growth; the top 1% took 60% of the increase in national income (are these the same thing??)

Chapter 9: inequality of labour income

• today, we have a patrimonial middle class: went from a society of superrentiers to a society of mostly managers and a few rentiers
  • wage inequality can be partly explained by a race between technology & education (at least, relative group position)
  • democratisation of educational system in France in 20th century, unfortunately did not eradicate inequality (incidentally, I read an interesting take on the educational system as an outlet for “hidden Keynesianism” in the excellent book Does Capitalism Have a Future)
  • in the US: high cost of tuition, obvious ramifications (if they invested more in accessible education, could potentially reduce inequality for the lower deciles, at least until credential inflation catches up …)
• interesting to compare minimum wage over time in France vs the US
  • France: climbing fairly steadily, whereas in the US it’s a weird sinuous pattern with fits and starts
  • disappearance of daily wage in 20th ct: now monthly (or biweekly in some places I guess)
  • econ arguments for a min wage: workers have too little bargaining power usually (esp due to the existence of a reserve army of labour), and if it’s already below marginal productivity costs, then raising it won’t reduce employment (at least theoretically, assuming everyone is a rational actor)
• on the supermanager phenomenon
  • mostly an Anglo-Saxon phenomenon (though spreading)
  • not just technological: there’s a ratchet effect inherent in this due to high mobility & artificial funnel restrictions (credentials, “we can’t lower the bar!”, etc)
  • there’s no objective way of measuring how much an exec “deserves” so there’s always an incentive to try to get paid more
  • also reflects the ideology of the context (society, corporation) and whether or not there are checks and balances against high exec pay
  • “meritocratic extremism”: modern societies feel compelled to reward “winners” more generously if they give the impression that they accomplished what they did through “merit”

Chapter 10

• France, 1791, after nobility’s fiscal privileges were abolished, a tax on estates/gifts was set up
  • the actual amount was minor; the real goal was to establish a wealth registry which would then allow for the preservation of property rights in perpetuiry
  • France’s wealth inequality has been structurally the same throughout history (though the actual numbers have fluctuated due to war, etc)
• in the US, wealth was more concentrated around end of 19th century, catching up to Europe
  • which worried US economists because they were proud of the fact that the US had historically been more equal (how times have changed)
• main reason for high wealth concentration pre-WWI: in low-growth societies when r > g, returns to capital will ofc compound
  • the Q is: why was r > g? Piketty says it’s a historical fact but not a logical necessity (taxes on wealth played some role)
  • otoh, pure r (once you subtract tax and capital losses) briefly fell below g during wars (which reduced wealth ineq for some time)
  • so r > g depends on existence of policies/instutitions to regulate the capital-labour relation, plus exogenous shocks to capital like war
  • r has been historically around 4-5% (pre-losses) which is curious
• dynamics of r & g
  • if r > g, eventually capital-income ratio rises to unsustainable levels
  • in the long run, this will result in a decrease in r (as the general economic environment gets so bad that investment opportunities decline … like if everyone is just dying of hunger or people are getting guillotined etc. unfortunately, Piketty never goes into specifics, but it’s fun to imagine)
  • historical changes in laws around wealth inheritance: from primogeniture (first son/child) to equipartition
  • in the long run, we should arrive at an equilibrium—a Pareto distribution whose coefficient reflects r-g
  • but that’s only true for a specific range of r-g. if r > g by too much, then there is no equilibrium: capital’s share of income will increase without limit (until external shocks, at least)
    • this is a bit fishy as a theory because he’s basically including anything that doesn’t arise automatically from the formulas as an “external shock” which makes it almost tautological
• reasons wealth ineq is no longer at Belle Époque levels:
  • rentiers in interwar years didn’t reduce their expenses enough, thus eating into their capital (and not just living off income)
  • composition of assets vulnerable during wars (mostly foreign assets, esp sovereign debt)
  • redistribution of wealth in europe after wars: progressive tax, nationalisation, etc
  • also not enough time has passed since 1945—ineq can still rise quite a bit
  • structural changes in 20th ct: governments started taxing capital income at higher rates
    • the effect was not to reduce the total amount of private wealth but rather to change the structure of it
    • more progressive estate taxes esp in 20th ct France
• if demographic growth is negative, inherited wealth could play bigger role in developed countries
• summary: wealth being less concentrated today than it used to be is a result of both political institutional choices and accidents

Chapter 11: merit and inheritance

• main point: when r > g to a significant degree, inheritance will predominate over this lifetime’s savings
  • i.e., the past will begin to devour the future
  • so past wealth inequalities will be distorted (worsened) over time
• methodology for tracking inheritance over time:
  • economic flow, which takes the product of:
    • μ: average wealth at time of death
    • m: mortality rate
    • β: capital-income ratio but just for private wealth
  • this definition is kind of a tautology but it’s a useful approximation of actual fiscal flow (i.e., real inheritance data)
  • ofc μ depends on age profile & consumption patterns (if savings are meant to be consumed during retirement or are accumulated to pass on to children)
• basically we can’t expect disappearance of importance of inherited wealth unless we impose concrete policies to ensure it (like a 100% inheritance tax :D)
• on how increased life expectancy affects inherited wealth
  • 19th century, average age of inheritance: 30
  • 21st century: 50
  • basically inheritance occurs later in aging societies
  • but ofc wealth ages too (when r > g) and so the effects kind of cancel each other out, at least when it comes to the amount (may change dynamics given that life at 50 is not the same as life at 30)
• Modigliani triangle theory: wealth increase in anticipation of retirement then decreases during retirement
  • problems: people don’t just accumulate wealth for retirement; they may die early, or may be intending to pass on their wealth
  • without public pensions, wealth accumulation might be higher than it is today
• gifts constitute about half of all present inheritance flows (so v important)
  • can explain why regular inheritance is lower now—because some people have already passed on a lot of their assets
• projection for 21st ct: inheritance and gifts will both increase, proportional to r-g
• today, democracy rests on a “meritocratic hope” but there’s no guarantee that illusion will remain as inherited wealth dominates more and more
  • important to note that rent/inheritance are not just “imperfections” in the market; they are core features of capitalism!!!

Lecture

• Before Piketty’s book came out, we didn’t really have data on inequality over time, especially historically
  • now, though, we have the data to see that the inequality rankings for countries are roughly constant over time (i.e., cross-nationally similar, though longitudinally varying)
  • Piketty’s focus on capital-income ratio is better at explaining longitudinal variation than variations among countries (which makes sense, since he neglects the political dimensions that we know to be important)
• we can look at inter-country differences by clustering them according to broadly similar longitudinal trends (or economic factors) for share of pre-tax income earned by the top 1%
  • the Anglo-Saxon group (UK, US, AU, CA) mostly similar
  • continental Europe & Japan: also similar to each other, but unlike the Ango-Saxon countries, there’s no dramatic shift post-1980s (neoliberalism didn’t extend into these countries in the same way)—inequality remained roughly stable in that period, with maybe a small decline
  • North and South Europe (France, Italy, Denmark, Spain): Denmark diverged the most (lower than the others). it’s strange because Italy and Spain have much higher income inequality (by Gini) than France, but they’re very close to France in this graph
• Gini is obviously a very reductive and flawed measure—some alternatives include 90:10 or 90:50 ratio, or percentile shares (top 1% share of income etc)
  • worth considering the diff between pre-tax/pre-fiscal/market income (before all government transfers and payments) & post-tax/post-fiscal/disposable income
  • ofc, pre-tax income is really just a social construct, i.e., fiction
  • (side note: imagine if job offers were only given on the basis of post-tax income. that would change our perception of what we “earn” dramatically and could weaken the whole “taxation is theft” POV)
  • on adjusting for different household sizes: it’s complicated by the fact that household structures have been changing a lot recently (more single people, more dual earners, more young people still living with their parents)

The Meltzer and Richard model

(The 1981 theory proposed by Allan H. Meltzer and Scott F. Richard that was discussed last class. I personally think it’s extremely flawed but I guess it’s worth understanding better.)

• background on the authors: they’re conservative economists, skeptical of govt action (part of the “public choice theory” school of thought, and influenced by Anthony Downs)
  • contrast w/ John Stuart Mill: wanted to expand franchise and aware of the dangers that could pose to capital, but whose solution was to expand education to ensure more trustworthy voters
  • Anthony Downs, published An Economic Theory of Democracy in 1957: political science treatise marrying economic theory & non-market political theory
    • very basic model, based almost entirely on the US political system (assumes a 2-party system)
    • posits that an electorate will be normally distributed along a single issue dimension, with the median at the centre (which is really taking the “left/right/centrist” metaphor too far, imo)
    • thus, parties will converge in the centre in order to appeal to the median voter
    • brief aside from Hopkin on the limits of the left/right/centre model: “I consider Trump and Clinton to both be fairly right-wing in economics” (but she’s more left-leaning on the subject of taxation and more right-leaning when it comes to globalisation/borders)
    • if we try to apply this to the UK: Conservatives on the right, Labour on the left, and the Lib-Dems at the centre would suggest that the Lib-Dems will win the next election (which seems quite unlikely)
    • the big assumption here is the “median voter” which is starting to feel like an increasingly fictitious figure as voters are more and more polarised (which this model doesn’t really account for—instead, it predicts that extremist views will be dampened as politicians try to cater to moderates)
• anyway, around the time that Meltzer and Richard published their paper, the political movement they were part of (neoliberalism) managed to seize state power and thus halt the growth of the state (so I guess they achieved what they wanted to but ofc that means their theory became mostly irrelevant)

The impact of different electoral systems

• UK: first past the post (a form of majoritarian/plurality system)
  • an alternative is proportional representation
• another aspect to consider is that of systematic voter exclusion
  • in the US: disenfranchisement of, especially, minority voters (incarceration, voter ID laws, etc)
• Presidential election systems are majoritarian by definition
  • you end up with winner-takes-all logic where there’s no incentive to share power with weaker groups
• on the local level, in a majoritarian system, you can end up with an area being represented by someone for whom only a minority of people voted
• in a proportional system, on the other hand, small parties can still have some say
  • whereas larger parties don’t get inflated majorities & thus must seek alliances to form coalition govts
• empirically, there’s a correlation between proportional representation & larger welfare states
  • the Anglo-Saxon countries are all majoritarian
  • exceptions: France which is sort of majoritarian (via 2 rounds) but has a large welfare state
  • PR tends to result in more left-wing governments (research by David Soskice of LSE’s Government department)
• of course, it’s not just the electoral system that matters—the situation is complicated by multicollinearity
• incidentally, “Barack Obama is considered a liberal or a lefty in the US, but in Sweden they would put him in the Conservative Party” which is v true (and something I didn’t realise until fairly recently)
• the US is a complicated system, electorally:
  • consensus democracy in some respects
  • federalism, bicameralism, constitutionalism, separation of powers
  • but FPTP electoral system
  • so we have conflicting forces

Why don’t people vote for greater distribution?

• empirically, Meltzer and Richard’s model fails to predict actual behaviour
• possible reasons why:
  • at some point, the (perceived) marginal gains from further redistribution outweigh the cost, and so middle-income voters believe that they’ll gain more from tax cuts
  • a social-structural explanation: rise in property ownership makes people more politically conservative (they become aligned with the interests of capital since they now own assets)
  • a change in population dynamics: people are living longer and having fewer children (and age is a huge factor when it comes to political views)
  • cultural change: post-materialist concerns (like identity, religious views)
  • and, of course, the elephant in the room that is always lurking beneath the ideal of democracy: the fact that voters don’t really understand, or care to understand, what the choices really are (obviously connected to the education system and the media industry)

Seminar

Some topics discussed:

• why does Piketty go on for so long: to bulletproof his args? or cus he wanted the apparent accomplishment of having written a 600-page book
• why does he talk about the effects of policies and institutions on ineq?
  • my take: it’s not just optimism (in the sense that: we could reduce it if we wanted); he has to explain differences between countries, and historically, and the cap-income ratio isn’t enough
• I brought up Goodhart’s law & the danger of a measure becoming a target when reducing inequality
  • Piketty talks a lot about the flaws of scalar measures like Gini, etc for measuring something as multidimensional as inequality
  • and when you focus too much on these measures then it’s tempting to target them—like saying we need to reduce Gini (but ofc there are different ways of doing that, and not all of them are necessarily worth doing)
    • for ex, post-crisis, inequality has gone down in many areas, but not always for a good reason
    • it’s a relative measure, after all, and if people in the upper-middle suddenly do a lot worse, and people in the bottom do a little worse, the Gini might improve but the outcome is prob not desirable
  • you also have to keep in mind the assumptions & choices inherent in any particular measure (for ex, with Gini, you can do pre- or post- tax)
• why is ineq so much higher in the US?
  • ideology plays a key role (the American Dream as a way of preserving “meritocracy” beyond all reason)
  • race as a component: it’s easier to argue against redistribution if poverty is concentrated among ethnic minorities (or really people who just don’t “look like” you for some reason)
    • but ofc race discrimination in the US is historically linked to poverty so it’s easy to see why that plays a key role
  • educational system stratified, can’t keep up w/ technology
  • history of American exceptionalism and idea of meritocracy may well have been shaped by past events (esp with the cap-income ratio being initially quite low compared to Europe)
  • the role of quantitative easing in creating an asset bubble to boost capital(ism)
• question to consider: how does institutional structure allow shifts in public opinion to become policy (or prevent it?)
  • think about the Democratic Party doing their best to prevent Sanders from getting the nomination vs how Corbyn did manage to become leader
  • also: role of electoral college
• wonderful quote from Hopkin: “I should be presenting you with a lot of neoliberal arguments about why inequality is a natural consequence of the beauty that is capitalism”
  • coincidentally, that would also be a fairly leftist strong argument for transcending capitalism

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