Home > Uncategorized > Wages, profits, and inequality

Wages, profits, and inequality

from David Ruccio

One of the legacies of the hegemony of neoclassical economics in the postwar period was a general lack of interest in issues pertaining to inequality, especially the analysis of the role of class in causing inequality in the distribution of income.

Unlike both classical economists (such as David Ricardo) and critics of classical economics (such as Karl Marx), postwar neoclassical economists weren’t much concerned with the class—or, as they referred to it, the functional—distribution of income. The argument was that factor (labor and capital) shares were relatively constant and therefore not particularly important in explaining economic inequality or much of anything else.

Well, that has changed in recent decades, with growing inequality, the decline in the labor share, and the rise in the capital share of national income. The relation between class and inequality simply can’t be ignored any longer.

Or can it? 

Maura Francese and Carlos Mulas-Granados (pdf), in a recent paper for the IMF, noted that “the wage share has indeed been declining since the 1970s while inequality has been on the rise” but concluded that the declining labor share of income has not been a key driving factor for the growth in inequality.* Their analysis suggests that, instead,

the most important determinant of rising income inequality has been the growing dispersion of wages, especially at the top of the wage distribution.

The key question is, can those two results be reconciled? In other words, is it possible that growing inequality has been caused by changes in the class distribution of income and by the growing dispersion of wages?

Roser-1

Data on the income sources of the top 1 percent as shares of total income in the United States, illustrated by Max Roser, suggests the answer.

As is clear from the chart above, a growing share of the total income going to the top 1 percent has come from wage income (technically, wages, salaries, and pensions), beginning especially in the 1970s. That’s the fundamental difference between the two peaks in the share of income going to the top 1 percent, in 1929 and 2007:  then, most of their income came in the form of profits, dividends, interest, and rent; later, a growing percentage came in the form of wage income.

But, of course, the wages being paid to those in the top 1 percent are not the same as wages paid to everyone else. They represent, instead, a share of the surplus that is distributed to them in their role as CEOs of industrial corporations and employees in large financial institutions. So, they’re really a form of capital income—which, to keep things straight, should be added to the profit share and deducted from the wage share.

Once we make that adjustment, then contra Francese and Mulas-Granados, it becomes possible to connect growing inequality in the distribution of income to the declining wage share and to the growing dispersion of wages.

It’s the conclusion neoclassical economists fear and one they work so hard to banish from economic discourse: class changes have played an important role in make the distribution of income increasingly unequal.

* Readers will find a less technical presentation of Francese and Mulas-Granados’s argument here.

  1. Larry Motuz
    December 10, 2015 at 3:25 pm

    Thank you for this!

  2. Larry Motuz
    December 10, 2015 at 5:04 pm

    What the marginalists/neoclassical economics succeeded at was removing the dreadful algebra of necessity from budget formation and spending decisions. This allowed them to ignore inequalities or perverse ‘income/wealth’ distributions. It also allowed them to ignore the process of budget formation out of income make various claims about the utility of money income.

    Whereas Ricardo was prepared to say that a person with two pecks of corn was twice as well of as the person with one — if the length of time one gets to eat matters at all — Stigler asserted that no such statement of value was permissible since value had to be looked at solely in monetary terms: exchange values rather than use values.

    If one looks at the use-values of increasing amounts of income, it is clear that the ‘utility’ (use-value) of increasing money income lies in the diversity of ‘uses’ having more money permits. More money frees one from the dreadful algebra of necessity. Given the range of human needs, including the need for some satisfaction in consumption as well as real benefits from it, ‘more’ money allows for a greater diversity in what one may consume.

    That is why major income inequalities — especially from the skimming of the top — is so dangerous to broadly based human well-being and to economic activity.

    • December 10, 2015 at 6:02 pm

      “What the marginalists/neoclassical economics succeeded at was removing the dreadful algebra of necessity from budget formation and spending decisions.”

      Yes, but how? They talk in terms of opportunity to acquire value, not necessity. I’ve recently tried to draw attention to Figure 3 in Jevons’ ‘Theory of Political Economy’, where I was astonished to find the “utility” of the essential simply left unaccounted for. It might be too kind to assume this was due to his not having had Claude Shannon, Father of Information Science, explain to him the utility of having sufficient “redundancy” (inefficiency or slack) in the system to enable it to right itself when (inevitably) it fails.

      In any case, politicians soon had to bail out the employers by introducing national insurance against old age and unemployment. That this was financed not from profits but from wages was decently covered with a fig leaf of minimum wages.

      • Larry Motuz
        December 12, 2015 at 8:55 pm

        Visiting grandchildren this weekend.

        Off the top of my head, a quick reply:

        1. Start with Jeremy Bentham and his greatest happiness for greatest number principle. Though he acknowledges that ‘happiness’ is itself not measurable, he invents a felicific calculus that works on the principle that ‘if it could be measured, the measure would entail an ‘intensity’.

        2. William Stanley Jevons talks about the marginal degree of utility. This is the slope of an infinitesimal. The diminishing marginal utility of goods is assumed to be true. {Gossen had already done this but his work was largely unknown.] Marshall continues in this vein. It is necessarily the case that all mathematical functions which ‘exhibit’ diminishing marginal utility as more of x is taken on will also, by definition, leave consumers with a Consumer Surplus. Ipso facto, CS is said to exist because of the ‘law’ of diminishing marginal utility.

        3. Leon Walras invents general equilibrium in mathematical form. He does so by 1) ruling out any exchanges prior to the auctioneer ‘finding’ equilibrium [this on the assumption ‘proven’ by his ‘equations’ that such an equilibrium is possible; and 2) giving each person endowments of goods.
        Having abstracted away from any costs of production and any needs to use goods, the prices at which markets clear are not bounded by production costs nor by needs for benefits.
        .

        4.. Edgeworth creates his Edgeworth box with endowments. Edgeworth assumes that ‘utility’ is measurable and is maximized in exchange. This assumes that people are rational maximizers. “Endowments’ in Pareto and in Edgeworth replace any process of income formation; and, because these endowments are fixed, so are budgets.

        5. Ability to pay defines ‘consumers’. Marshall realizes that the process of budget formation cannot be explained, so he assumes that budgets are formed before the consumer enters the market and remains unchanged when prices change. Hicks, in effect, adopts these assumptions.

        That’s all I can suggest for now. Ask more questions if you want to. When back at home in a few days, I’ll answer them.

  3. December 10, 2015 at 8:11 pm

    “It’s the conclusion neoclassical economists fear and one they work so hard to banish from economic discourse: class changes have played an important role in make the distribution of income increasingly unequal.”
    Yes.

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    Reverse “ an economic recovery program that has privileged the recovery of financial markets and corporate profits has fueled the increase in wealth inequality, in the United States and across the world.”, reverse that program, make it fund “…a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defense, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity,…”
    “Capitalism is the “best” system to date devised by mankind. As it is administrated, perhaps, is where the “flaw” is manifested. If capitalism used its Central Bank properly,that is for the betterment of the common good, with equality and justice for all, capitalism would be the best ways and means to help “form a more perfect union….”, Pontifical C.
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    ““We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defense, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity,…””
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    ”http://archive.org/…/role…/roleofmoney032861mbp_djvu.txt

  4. BC
    December 11, 2015 at 3:10 am

    One must understand what happened since the 1970s, especially in terms of peak US oil production per capita, deindustrialization, financialization, and feminization of the economy and society, why it occurred, and who drove the process, and to whom the overwhelming share of the gains accrued.

    Primary factors:

    Thermodynamics: peak US oil production per capita (down 45% since 1970 and will decline 50% by the end of this decade, resulting in permanent depletion and irreversible decline per capita in industrial output per capita, i.e., see “Limits to Growth”) and declining net energy, entropy, and exergy;

    deindustrialization: offshoring/labor arbitrage, and globalization (Anglo-American imperial trade regime and the “China Miracle” being “made in the USA”);

    debt to wages and GDP increasing a differential order of exponential magnitude from the early 1980s into 2005-08, which was the precursor condition that resulted in the GFC, as occurred in 1929-30, 1890-93, and 1836-37, and Japan during the Asian Crisis in 1997-98;

    women entering the labor force en masse in gov’t, health care, education, retail, and financial services (now an equivalent of more than 50% of GDP and thus a prohibitively costly drag on the rest of the private sector, not unlike in the Eurozone where gov’t spending to GDP is ~50%), reducing overall labor product to GDP and productivity (less reflationary effects of increasing debt to GDP from falling nominal interest rates from the early 1980s);

    regressive taxation of earned income of working-classlabor versus favorable treatment of taxation of non-productive rentier speculation and unearned income, resulting in serial commodity and asset bubbles and busts, exacerbating inequality that would have otherwise occurred in any case because of demographics; and

    the emergence of the largely dismissed (or utterly unknown today by mainstream eCONomists) Marxian condition of the capitalist falling rate of profit (when properly adjusted for price effects, currency, inventories, and depreciation), indicating that the US/western firms are much less profitable than is perceived in strictly nominal terms or as a share of GDP; that is, after fully adjusting for the direct and indirect fixed and externalized costs of operations, private firms’ capacity to increase investment, production, profits, capital accumulation, and labor deployment and its purchasing power has been declining at an increasing rate since 2000 and 2007. The predictable result hereafter is the Long Wave Trough’s Schumpeterian depression-induced global mass consolidation of capacity across industries, as well as mass firings worldwide, price and asset deflation, fiscal constraints and risk of default, and global economic dislocation on an unprecedented scale.

    Peak Oil, population overshoot, resource depletion per capita, climate change, and “Limits to Growth” are converging at an unprecedented global scale to result in, and entrain conditions for, the End of Growth.

    Values, norms, expectations, and state policies that were deemed pragmatic and necessary during the Long Wave inflationary regime of the 1950s-70s and supply-side, reflationary regime of the 1980s to 2007 will be altogether inappropriate, even misguided and self-defeating, during the remaining Long Wave deflationary regime hereafter into the 2020s.

  5. December 11, 2015 at 5:10 pm

    Wages and profits are not the components of income
    Comment on ‘Wages, profits, and inequality’

    The trouble with distribution theory started with Ricardo who got the distinction between wage, profit and rent wrong (2011). Then Marx got the class theory of profit wrong (2014a). Neoclassical distribution theory, of course, hit rock bottom, but Keynesianism did not perform much better, and Heterodoxy alone has multiple profit theories that do not fit together*.

    Yes, distribution theory has always been the deepest morass of economics. For the correct approach see (2014b).

    Egmont Kakarot-Handtke

    References
    Kakarot-Handtke, E. (2011). When Ricardo Saw Profit, He Called it Rent: On the Vice of Parochial Realism. SSRN Working Paper Series, 1932119: 1–19. URL
    http://ssrn.com/abstract=1932119.
    Kakarot-Handtke, E. (2014a). Profit for Marxists. SSRN Working Paper Series, 2414301: 1–25. URL http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2414301.
    Kakarot-Handtke, E. (2014b). The Profit Theory is False Since Adam Smith. What About the True Distribution Theory? SSRN Working Paper Series, 2511741:
    1–23. URL http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2511741

    * See ‘Heterodoxy, too, is scientific junk’
    http://axecorg.blogspot.de/2015/09/heterodoxy-too-is-scientific-junk_85.html

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