Home > Uncategorized > How rigged markets make the rich richer

How rigged markets make the rich richer

from Lars Syll

rigged_coverMarkets are never just given. Neither God nor nature hands us a worked-out set of rules determining the way property relations are defined, contracts are enforced, or macroeconomic policy is implemented. These matters are determined by policy choices. The elites have written these rules to redistribute income upward. Needless to say, they are not eager to have the rules rewritten — which means they also have no interest in even having them discussed.

But for progressive change to succeed, these rules must be addressed. While modest tweaks to tax and transfer policies can ameliorate the harm done by a regressive market structure, their effect will be limited. The complaint of conservatives — that tampering with market outcomes leads to inefficiencies and unintended outcomes — is largely correct, even if they may exaggerate the size of the distortions from policy interventions. Rather than tinker with badly designed rules, it is far more important to rewrite the rules so that markets lead to progressive and productive outcomes in which the benefits of economic growth and improving technology are broadly shared.

Dean Baker’s new book forcefully argues that mainstream textbook economics has pretty little in common with the real world in which we actually live. Especially when it comes to the mainstream neoclassical paradigm of income distribution, Baker convincingly shows how wide is the gap between mainstream economic theory and reality.  

Economics textbooks usually refer to the interrelationship between technological development and education as the main causal force behind increased inequality. If the educational system (supply) develops at the same pace as technology (demand), there should be no increase, ceteris paribus, in the ratio between high-income (highly educated) groups and low-income (low education) groups. In the race between technology and education, the proliferation of skilled-biased technological change has, however, allegedly increased the premium for the highly educated group.

Another prominent explanation is that globalization – in accordance with Ricardo’s theory of comparative advantage and the Wicksell-Heckscher-Ohlin-Stolper-Samuelson factor price theory – has benefited capital in the advanced countries and labour in the developing countries. The problem with these theories are that they explicitly assume full employment and international immobility of the factors of production. Globalization means more than anything else that capital and labour have to a large extent become mobile over country borders. These mainstream trade theories are really not applicable in the world of today, and they are certainly not able to explain the international trade pattern that has developed during the last decades. Although it seems as though capital in the developed countries has benefited from globalization, it is difficult to detect a similar positive effect on workers in the developing countries.

There are, however, also some other quite obvious problems with these kinds of inequality explanations. The World Top Incomes Database shows that the increase in incomes has been concentrated especially in the top 1%. If education was the main reason behind the increasing income gap, one would expect a much broader group of people in the upper echelons of the distribution taking part of this increase. It is dubious, to say the least, to try to explain, for example, the high wages in the finance sector with a marginal productivity argument. High-end wages seem to be more a result of pure luck or membership of the same ‘club’ as those who decide on the wages and bonuses, than of ‘marginal productivity.’

Mainstream economics, with its technologically determined marginal productivity theory, seems to be difficult to reconcile with reality. Although card-carrying neoclassical apologetics like Greg Mankiw want to recall John Bates Clark’s (1899) argument that marginal productivity results in an ethically just distribution, that is not something – even if it were true – we could confirm empirically, since it is impossible realiter to separate out what is the marginal contribution of any factor of production. The hypothetical ceteris paribus addition of only one factor in a production process is often heard of in textbooks, but never seen in reality.

When reading  mainstream economists like Mankiw, who argue for the ‘just desert’ of the 0.1 %, one gets a strong feeling that they are ultimately trying to argue that a market economy is some kind of moral free zone where, if left undisturbed, people get what they ‘deserve.’ To most social scientists that probably smacks more of being an evasive action trying to explain away a very disturbing structural ‘regime shift’ that has taken place in our societies. A shift that has very little to do with ‘stochastic returns to education.’ Those were in place also 30 or 40 years ago. At that time they meant that perhaps a top corporate manager earned 10–20 times more than ‘ordinary’ people earned. Today it means that they earn 100–200 times more than ‘ordinary’ people earn. A question of education? Hardly. It is probably more a question of greed and a lost sense of a common project of building a sustainable society.

Since the race between technology and education does not seem to explain the new growing income gap – and even if technological change has become more and more capital augmenting, it is also quite clear that not only the wages of low-skilled workers have fallen, but also the overall wage share – mainstream economists increasingly refer to ‘meritocratic extremism,’ ‘winners-take-all markets’ and ‘super star-theories’ for explanation. But this is also highly questionable.

Fans may want to pay extra to watch top-ranked athletes or movie stars performing on television and film, but corporate managers are hardly the stuff that people’s dreams are made of – and they seldom appear on television and in the movie theaters.

Everyone may prefer to employ the best corporate manager there is, but a corporate manager, unlike a movie star, can only provide his services to a limited number of customers. From the perspective of ‘super-star theories,’ a good corporate manager should only earn marginally better than an average corporate manager. The average earnings of corporate managers of the 50 biggest Swedish companies today, is equivalent to the wages of 46 blue-collar workers.

It is difficult to see the takeoff of the top executives as anything else but a reward for being a member of the same illustrious club. That they should be equivalent to indispensable and fair productive contributions – marginal products – is straining credulity too far. That so many corporate managers and top executives make fantastic earnings today, is strong evidence the theory is patently wrong and basically functions as a legitimizing device of indefensible and growing inequalities.

austerity22No one ought to doubt that the idea that capitalism is an expression of impartial market forces of supply and demand, bears but little resemblance to actual reality. Wealth and income distribution, both individual and functional, in a market society is to an overwhelmingly high degree influenced by institutionalized political and economic norms and power relations, things that have relatively little to do with marginal productivity in complete and profit-maximizing competitive market models – not to mention how extremely difficult, if not outright impossible it is to empirically disentangle and measure different individuals’ contributions in the typical team work production that characterize modern societies; or, especially when it comes to ‘capital,’ what it is supposed to mean and how to measure it. Remunerations do not necessarily correspond to any marginal product of different factors of production – or to ‘compensating differentials’ due to non-monetary characteristics of different jobs, natural ability, effort or chance.

Put simply – highly paid workers and corporate managers are not always highly productive workers and corporate managers, and less highly paid workers and corporate managers are not always less productive. History has over and over again disconfirmed the close connection between productivity and remuneration postulated in mainstream income distribution theory.

Neoclassical marginal productivity theory is obviously a collapsed theory from both a historical and a theoretical point of view, as shown already by Sraffa in the 1920s, and in the Cambridge capital controversy in the 1960s and 1970s.

When a theory is impossible to reconcile with facts there is only one thing to do — scrap it!

  1. August 8, 2017 at 12:57 pm

    Never had to worry about scrapping it! Never accepted it from the beginning. Most longshoremen or mechanics with a high school education and brains not addled by alcohol or drugs knows this is crap. Why do supposedly smarter economists not know it’s crap?

  2. August 9, 2017 at 10:52 am

    “When a theory is impossible to reconcile with facts there” are two things to do — find another theory which IS reconcilable with the facts, THEN scrap the first!

    • August 10, 2017 at 6:28 am

      Dave, you make it sound simple and straight forward. If it is simple and straight forward, why hasn’t it been done already? Why? Because it’s not simple and straight forward. In his book, “Constructing Quarks, A Sociological History of Particle Physics,” Andrew Pickering (Sociologist/Physicist) writes (please excuse the long quotation),

      “In the scientist’s account, experiment is seen as the supreme arbiter of theory. …There are, though, two well-known and forceful philosophical objections to this view, each of which implies that experiment cannot oblige scientists to make a particular choice of theories. First, even if one were to accept that experiment produces unequivocal fact, it would remain the case that choice of a theory is underdetermined by any finite set of data. It is always possible to invent an unlimited set of theories, each one capable of explaining a given set of facts. Of course, many of these theories may seem implausible, but to speak of plausibility is to point to a role for scientific judgment: the relative plausibility of competing theories cannot be seen as residing in data which are equally well explained by all of them. Such judgments are intrinsic to theory choice, and clearly entail something more than a straightforward comparison of predictions with data. Furthermore, whilst one could in principle imagine that a given theory might be in perfect agreement with all of the relevant facts, historically this seems never to be the case. There are always misfits between theoretical predictions and contemporary experimental data. Again judgments are inevitable: which theories merit elaboration in the face of apparent empirical falsification, and which do not?

      The second objection to the scientist’s version is that the idea that experiment produces unequivocal fact is deeply problematic. At the heart of the scientist’s version is the image of experimental apparatus as a ‘closed’, perfectly well understood system. Just because the apparatus is closed in this sense, whatever data it produces must command universal assent; if everyone agrees upon how an experiment works and that it has been competently performed, there is no way in which its findings can be disputed. However, it appears that this is not an adequate image of actual experiments. They are better regarded as being performed upon ‘open’, imperfectly understood systems, and therefore experimental reports are fallible.

      Missing from the scientist’s account, then, is any apparent reference to the judgments entailed in the production of scientific knowledge- judgments relating to the acceptability of experimental data as facts about natural phenomena, and judgments relating to the plausibility of theories. But this lack is only apparent. The scientist’s account avoids any explicit reference to judgments by retrospectively adjudicating upon their validity. By this I mean the following. Theoretical entities like quarks, and conceptualisations of natural phenomena like the weak neutral current, are in the first instance theoretical constructs: they appear as terms in theories elaborated by scientists. However, scientists typically make the realist identification of these constructs with the contents of nature, and then use this identification retrospectively to legitimate and make unproblematic existing scientific judgments. Thus, for example, the experiments which discovered the weak neutral current are now represented in the scientist’s account as closed systems just because the neutral current
      is seen to be real. Conversely, other observation reports which were once taken to imply the non-existence of the neutral current are now represented as being erroneous: clearly, if one accepts the reality of the neutral current, this must be the case. Similarly, by interpreting quarks and so on as real entities, the choice of quark models and gauge theories is made to seem unproblematic: if quarks really are the fundamental building blocks of the world, why should anyone want to explore alternative theories?”

      I know this is a lot to take in. But I believe Pickering better than most in the sociology of science (maybe because he is a world-renowned physicist) makes clear the basic issues in understanding how science works. Perhaps his insights and those of other sociologists of science can help reveal how economics currently works and search for options to change how it works. But just looking for the theory that corresponds with “facts” will not work.

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