Home > Uncategorized > Mainstream theories of income distribution

Mainstream theories of income distribution

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.

As has become abundantly clear to students of economics these days, mainstream textbook economics has pretty little in common with the real world in which we actually live. Especially when it comes to the mainstream theories of income distribution, the gap between theory and reality is ocean wide.

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 is​ 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 ​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 in​ 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 wants​​ to recall John Bates Clark’s (1899) argument that marginal productivity results in an ethically just distribution, that is not something – even if it was​ 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 theatres.

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 teamwork​ 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. Ikonoclast
    April 8, 2019 at 12:33 am

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

    I agree… in theory. I raise the following points not to make trivial and irritating objections, but to ask the central question. How do we scrap a false theory in practice, first at the personal and then at the social level? I can dismiss a false theory (one that is empirically falsifiable or metaphysically improbable from an empirical standpoint) from my mind after reading, research and mental effort. I mean a false theory that was inculcated into me when I was younger and more impressionable, as young people and students usually are.

    Not everyone even has the above epistemological model; namely that truth claims need to be subjected to empirical testing where that is possible and otherwise need to be subjected to philosophical and methodical doubt, using empirically warranted knowledge as an Occam’s Razor. Further, this needs to be supplemented by “Hitchen’s Razor”. In contrast, many still operate on the faith-reasoning model of truth; namely that some given dogma, in which they have been indoctrinated, states the Truth and this is the Absolute Truth and cannot be questioned.

    Dismissing a false theory leaves an ideational vacuum. Losing an explanatory or justificatory theory does not in and of itself provide one with a new theory. I may or may not be able to raise up my own new theory, for example. I’ve actually tried as an autodidact amateur to link priority monist ontology to complex systems philosophy/science to economics and such an undertaking is not easy. So far, I have possibly made some minor piecemeal progress but overall I have failed to develop anything like a coherent theory. I have even less idea how I could test such a theory. I won’t elaborate my attempts here. That is not the point of this post.

    Given that amateurs, the great majority of humanity, cannot do climate science and cannot do the philosophy of economics, then in each case they are thrown back on experts. A person with basic scientific literacy, say an education in the hard sciences and math to high school senior (age 17), can understand climate science to a good basic level if they make the effort; sufficient to see that it is science and how it might be able to make climate predictions within reasonable degrees of probability.

    The case gets harder with economics. It is not a science and it is not reducible to science or physical quantisation, except in some sub-disciplines. Political economy is really a branch of Moral Philosophy where it was originally situated. The issue then is that if there is only a minority or a slim majority of science literate people able to comprehend the basics of climate science, then the case is even worse with Moral Philosophy in relation to economics.

    The shape of the economy, within the possibility space limits of the real, is determined by culture and technology but also by prescriptions and beliefs. Today, the prescriptions are mostly laid down by those in power, the 1% or even the 0.1% and the acquiescence of the majority is founded first on carrots and sticks but also on an essential belief in the system as the best possible or only possible system; certainly as the only conceivable system. The possibility of other systems has been expunged from minds and the education system for at least 40 years. History, Economic History and Moral Philosophy have all been wiped off the curriculum for the most part.

    It’s getting harder and harder to even conceive of another system. As one joker put it, “It’s easier to imagine the end of the world than the end of capitalism.” Indeed, the totalising system of capitalism is now so effective it indeed may take the end of the world, which seems quite probable quite soon from climate change and limits to growth, to end it. Arguments have to be taken back into Moral Philosophy in an effort to avoid the cataclysmic end scenario. However, the return to Moral Philosophy cannot be a return to dogamtism. That’s not an easy thing to effect either; moral philosophy without dogmatism. In my view, that will come down to arguing for consequentialist rather than deontological ethics.

    Free market philosophy itself is built on deontological ethics. It’s a set of prescriptions for market structures, property law and income distribution. The axiomatic-deontological aspect comes first and the empirical-consequentialist aspect comes second. The whole system says, “Follow these rules and the outcomes will be right”. Indeed, the outcomes, no matter what, are held to be right by initial moral definition. An empirical-consequentialist view says, “These outcomes are ethically reprehensible in themselves, therefore the rules must be wrong.”

    Finally, how are we going to get the average person to understand these arguments? More and more objective education is one issue. Science, Philosophy and History have to be key subjects in every faculty, including in the science and economic faculties. The appeal to the ordinary person in the street has to be outcomes on the ground, affecting themselves and the ordinary majority of the people. This is not an original view of course. It’s the same old democratic socilaism argument. How to operationalise it in praxis is the key question.

    This reply is already too long. If people want to follow this lead, we could debate it further. Equally, other tacks are possible. Ideally, I’d like to see people directly address the original post (I hope I have done so) and also I’d like to see the original authors engage more in the subsequent thread, at least if they feel there are ideas there worth engaging with. Maybe we could view this as a democratic request from below.

    • Frank Salter
      April 8, 2019 at 10:29 am

      You are correct. You describe the symptoms of the problem of falsification by comparison with the empirical evidence. I believe the reason is simple. If economists actually did this, they would discover that there is not one valid conventional economic hypothesis. To support their delusions they refuse to understand the scientific method for it reveals that they have no valid theory. That is a bitter pill to swallow. I tried to discuss this with one professor of economics. He applied neoclassical analysis perfectly correctly and came up with a result which he knew as false to fact. What he refused to recognise was that he had come to a reductio ad absurdum position. He refused to accept that his own logic was correct. His derivation was so simple that it could not be wrong. To accept that neoclassical analysis was wrong was beyond him.

      However, this type of thinking is, at times, replicated on these blogs. The quantity calculus makes all production functions merely concrete representations of the data set they represent. Thus the whole of conventional growth theory is simply wrong. One would hope that this would be reflected in moving the discussion forward to that which is not-invalidated by the empirical evidence. There are such analyses.

  2. April 8, 2019 at 4:43 pm

    “When a theory is impossible to reconcile with facts there is only one thing to do — scrap it!” This is inadequate. In practice, theories only disappear when they are replaced by something (seen to be) better. This is standard practice in the natural sciences, and the failure to do this is the central problem with economics.

    A trivial point? Maybe. But it means that instead of continually complaining about how bad neoclassical or standard or textbook or mainstream economics is (reactive mode), the important thing is to develop theory that really does explain how the world works (selective replacement mode). And by “theory” here, I do not just mean a different model, I mean an empirically-based causal theory. This is how natural sciences like biology and geology operate (see https://www.cogentoa.com/article/10.1080/23322039.2017.1280983.pdf).

    It is eminently possible in economics! – for more on this, see https://evidence-based-economics.org/.

    • Frank Salter
      April 9, 2019 at 8:43 am

      I am in complete agreement. However whenever I refer to my “Transient analysis” (RWER-81), which is in total accord with the empirical evidence. the trolls appear and deliberately misrepresent what the paper says. The kindest view is that they are incapable of understanding the maths and will not examine the empirical evidence which requires many references to be followed. So there is one non-invalidated example of production theory. It is a start.

  3. Ikonoclast
    April 11, 2019 at 1:49 am

    I’ve written elsewhere to the effect that creating new theory and practice is not a trivial undertaking. Furthermore, the theories will arise from the various contending heterodox schools. Having contending heterodox schools remains important. Thence, these theories must interact with real world praxis and events to produce, finally perhaps, a new, consistent theory capable of being put into practice. We still cannot envisage what will emerge in full, just as people in a feudal system could not envisage the emergence of capitalism.

    I wrote “how are we going to get the average person to understand”? The key juncture will arise when inequality is too great and/or serious ecological problems, climate change etc. begin to seriously impact on the lives of ordinary people. This will be the era when the current system comprehensively fails to deliver the goods. One or more heterodox schools need to be ready with a workable theory at that point and one which can be explained rhetorically to the people.

    At the same time, one should not take a wholly elitist view, namely that only elite intellectuals will be able to theorise a way forward. The populace themselves will understand the system as failing when it IS patently and palpably failing. They will produce novel solutions from the ground up. When and if some solutions are seen to work, they in turn can be theorized in a form which permits replication of their essential functional features, and thus propagated as solutions.

    I don’t think anyone can formulate a complete, neat theory right now which can prescribe all necessary actions, now, before the times are ripe so to speak. Some solutions will arise, if they arise at all, at the very height and cusp of the crisis.

  4. Ikonoclast
    April 11, 2019 at 5:56 am

    Frank Salter,

    I am not qualified to comment on your paper “Transient analysis” (RWER-81) as I am not a mathematician. I can only make some general observations based on understanding some paragraphs in English which do not require extensive mathematical knowledge to contextualize them. Clearly this means that while I might understand some disparate parts of the essay in isolation, I cannot form a coherent understanding of the whole paper. In its entirety it is beyond my grasp. Keeping that in mind I would say;

    1. Those who would troll what they cannot even understand are certainly below notice.

    2. Considering passages like this;

    “The very methods employed by neo-classical economists have dictated the subject matter and militated against such a development…. In the analysis of economic performance through time it contained two erroneous assumptions: (i) that institutions do not matter and (ii) that time does not matter.”

    and this;

    “In science and engineering, it is a necessary condition that, when equations are used to represent physical reality, they are dimensionally correct. Failure to satisfy this condition is considered proofthat any such representation is wrong.”

    These indicate to me an avowed intention of remaining empirical in method and theory. And the first also contains a valid critique of neo-classical economics, in my view. This is the right way, in principle, to approach such matters, again in my opinion.

    3. However, I am concerned about this passage;

    “The many arguments against the use of aggregate production functions, based on heterogeneity (Felipe and Fisher, 2003; Felipe and McCombie, 2014; Felipe and McCombie, 2013), must therefore be seen in context. If the numeraire (generally money) presents an affine transformation from the theoretically valid labour-time measurements then the resulting equations will be representative of the underlying reality and therefore economically useful. This is sufficient to explain the widespread and successful use of aggregate production relationships in macroeconomic analysis.”

    The statement “If the numeraire (generally money) presents an affine transformation from the theoretically valid labour-time measurements then the resulting equations will be representative of the underlying reality and therefore economically useful.”, is perhaps concerning.

    I wonder if money does present “affine transformation from the theoretically valid labour-time measurements”. If this assumption is invalid perhaps the theory then falls down.

    I wonder if you have read Bali Fix’s paper, “The Aggregation Problem: Implications for Ecological and Biophysical Economics”? It might have a bearing on your work.

    Click to access 20190100_fix_the_aggregation_problem_bpearq_preprint.pdf

    Of course, bear in mind my initial caveat. I am commenting from a position of mathematical ignorance. Therefore, if I have written something foolish or of no real import then my comments are also below serious consideration… but they are not trolling.

    One thing that concerns me about the difficulty of analyzing economics is that economic behavior in many way is dependent on “rules” as well as “laws”. Here I have to define “rules” and “laws” in my purview. By “rules” I mean legal-stye laws, regulations, customs, institutional rules and prescribed financial and administrative methods and techniques. These are all prescriptive systems for human behaviors including human manipulations of (non-scientific) symbol systems. Humans in turn may obey rules or disobey such rules; albeit in a relatively orderly economy rule-obedience or rule compliance is probably relatively high. By “laws”, on the other hand, I mean the fundamental laws uncovered by hard science.

    The economic state space (If I may use that term) is considerably conditioned by extant accepted or elite imposed rules. This is really the same as saying economics is conditioned by ideology. All my statement does is go down a level into detail and state that an applied economic ideology is the set of rules used to condition the particular kind of economics in question.

    Thus the so-called “laws” derived for any particular ideologically conditioned economics (and they are all ideologically conditioned) will be rule-conditioned and thus not hard laws in the fundamental laws of science sense. These conditioned economic “laws” are algorithmically determined by the rule set implemented by the ideology. The rule set is a set of algorithms for getting outcomes. In turn, problems arise when these algorithmic “recipes” run counter to real system possibilities (real environment and real human possibilities). In other words, moving forward in time, part of the theoretical state space of ideological economics will attempt to bulge beyond the empirically realistic state space of physics and biology. These are the limits as in limits to growth for example. In other words, the algorithmic prescriptions of neoclassical economics, for example, as an auto-pilot system in essence, will, to continue the analogy, fly the plane of the economy into “cumulo-granite”.

    • Frank Salter
      April 11, 2019 at 8:41 am

      Thank you for your thoughtful comments. Using the quality calculus one can prove that the abstract unit of productive output is labour-time. Labour-time is aggregative. This is why adding money produces useful results when used in macroeconomics. Labour-time is of course the classical unit of productive output.

  5. Ken Zimmerman
    April 16, 2019 at 11:30 am

    Lars, “policy choices” to describe how economies are created is overly formal and misses the base of economic life.

    An economy’s base is the social and material space that a community or association of people make in the world. Comprising shared material interests, it connects members of a group to one another, and is part of all economies. The base of a community changes over time and assumes many forms that vary by history and context. But it is not represented in economic theories, and our ordinary language often does not bring it to everyday awareness. The term ‘base’, however, is used in parts of Latin America, and studies from other parts of the world provide many examples of its presence. By twisting the lens on economic processes, we may help reveal the significance of the base, which underlies all economies and is connected to capital in market-dominated economies. But understanding the importance of the base, and the interwoven relation of community and markets, requires a broadened understanding of the sphere of economy.

    Ethnographers have demonstrated for more than a century that in other historical and ethnographic societies, as well as industrial ones, economy includes more than markets or the market-like exchange of goods and services. From an anthropological perspective, economy covers the acquisition, production, transfer and use of things and services. For example, material things are produced and processed outside formal markets, and many transfers take place through practices such as social allotment and apportionment, inheritance, dowry, bridewealth, bloodwealth, indenture and reciprocity, each mode having a variety of expressions. Modern (especially neoclassical) economics focuses primarily on market transfers or competitive bidding to the exclusion of these processes, unless the logic of market trade is used to interpret non-market exchanges that have different moral and social parameters. A neoclassical economist may model the formation of property rights and the initial acquisition of property as a way of avoiding negative externalities and providing a greater incentive to work and invest; even communal relationships, such as interactions within the family or firm, may be reduced to and modelled as the outcome of rational selections within constraints. Most economists, whether neoclassical, neoinstitutional or neoevolutionary, assume that the human is a rational and solitary agent. Acting under constraints, she/he selects goals and chooses means that maximize self-interest or welfare. This perspective on the human in society cuts against many anthropological assumptions and raises questions about use of the economists’ toolkit as a universal way of analyzing economy.

    In contrast to economists, anthropologists often assume that humans are connected or communal beings who build and destroy relationships, and who communicate by language and material things. To be human means being a person constructed in mentality, communication and relationships with humans and nonhumans. To act as a separated individual without communal connections, as in impersonal market trade, is a practice taken only in relation to sociality and culture, on which it depends. But building an economics on this anthropological presumption requires a new set of conceptual tools. The implications of this argument for notions about alienation, equality, property, development, modernization and well-being, as well as how we conduct ourselves and justify other forms of economy, are considerable.

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