Archive for September, 2010

If you’re so smart, why ain’cha rich?

September 22, 2010

If we take a random individual from the population of Australian taxpayers, what’s the probability that her personal income will fall somewhere within the range $20 000-$30 000, or between $120 000-$130 000?

Consider this an inversion of the previous post, in which we used published ATO statistics to examine the income share of various fractiles.

The columns below show the percentage of people whose annual incomes fall within each interval. The probabilities of course sum to unity (100%).

As we can see, individuals cluster within the interval $20 000-$40 000, with the number of taxpayers in each interval declining sharply thereafter as we move upwards along the income scale.  A small number of people receive a huge income.

Income distributions in the United States, Japan, the United Kingdom and Italy closely approximate this Australian pattern.

This is an interesting result. For all their similarities, these five countries differ greatly in labour-market regulation, industry composition, policy settings, degree of ‘social capital’ and spread of ‘human capital.’

Perhaps such details are not, after all, decisive factors in the determination of a country’s income spread.

Indeed there’s good reason to think that this broad pattern of inequality  in which many individuals end up with little income, and very few individuals wind up with a huge income  is a universal feature of market economies, and emerges wherever there is monetary trade by a large number of private agents (and a fortiori whenever a small class of property owners can hire the capacity to labour of those without productive assets).

Ian Wright’s simulation of a market economy involves an agent-based model in which zero-intelligence actors are initially given an equal endowment of resources, then partitioned into classes (employer, employee and unemployed) and led to interact in product and labour markets according to a few basic decision rules.

Just like a real market economy, there are local, micro-level interactions of agents, in which goods and services are exchanged for money. And, just like real market economies, the invisible hand produces macro-level regularities: patterns of income distribution etc.

As in the Australian data shown above, the simulation sees many agents end up with little income, and a small number wind up with a huge income.

Of course, the rich don’t owe their wealth to intelligence or effort (recall that these are zero-intelligence agents, without “strategies” or choice functions, who select a course of action by choosing randomly from a probability distribution).

Merely by the working of chance, a lot of money is bound to end up in the hands of a few.

What’s the upshot of this?

  1. Wherever a large body of private agents (individuals, firms) engages in monetary trade, a highly unequal income distribution is likely to result. This distribution may take a variety of forms (lognormal, power-law, exponential etc.), but its basic shape holds for all reasonable parameter values.
  2. The properties of this income distribution do not arise from individuals possessing unequal endowments of internal talents and capacities (intelligence, responsibility, propensity for hard work). Even with a uniform distribution of initial resources, random interactions and zero-intelligence agents, we end up with a few rich people and large number of low-income people.
  3. So long as market exchange is maintained, inequality of outcome will survive those measures imposing “equality of opportunity”, or “benevolent” welfare and tax policies.
  4. Quotas for disadvantaged groups  e.g. women or ethnic minorities  may increase the “diversity” of the upper strata (through, for example, preferential admission to elite collegiate programmes). But given the essential fixity of the income distribution, the shuffling of social positions is a zero-sum game. The granting of salvation to a special few of the reprobate does not increase the total number of elect; and merely consigns others to damnation in their place.

For left-wing radicals, the implications of this are obvious.

But centrist liberals, too, have cause for thought. Most of them, taking their lead from Ronald Dworkin, incline sympathetically towards a kind of luck egalitarianism. This position holds that inequality arising from unchosen circumstances  as opposed to that inequality which is deserved or for which agents are responsible  is unjust.

Thus Dworkin says:

[Unfair] differences are those traceable to genetic luck, to talents that make some people prosperous but are denied to others… [A just society aims to] neutralize the effects of differential talents… individuals should be relieved of responsibility for those unfortunate features of their situation that are brute bad luck, but not from those that should be seen as flowing from their choices.

John Rawls says that ‘those with similar abilities and skills should have similar life chances.’

But, as we have seen, market societies allocate stupendous wealth, not merely to the innately talented (like Wilt Chamberlain), but also to lucky morons.

Can liberal centrists rise to the challenge of justifying such a distributional order? The example of Dworkin suggests that they can.

In doing so, however, he and his acolytes commit a fallacy of composition. For the vagaries of market exchange and private property, as we have seen, entail the emergence of macro-social inequality even in the presence of identical agents with the same initial endowment of talents and capabilities.

‘Unfortunate features’ of capitalist society must therefore flow not from individual ‘choices’, but from a kind of ‘brute bad luck’: the basic institutions of society.

The young Marx, following the Classical economists, was on solider ground in suggesting that, on a social level, personal merit does not give rise to wealth ex ante. Rather, virtuous attributes intelligence, good taste, attractiveness are retrospectively ascribed to the wealthy because of their wealth.

Here Marx described the ‘power of money’, which Adam Smith had said conferred on its owners the ‘power to command’ labour and the products of labour:

That which is for me through the medium of money  that for which I can pay (i.e., which money can buy)  that am I myself, the possessor of the money. The extent of the power of money is the extent of my power. Money’s properties are my  the possessor’s  properties and essential powers.

Thus, what I am and am capable of is by no means determined by my individuality.

am ugly, but I can buy for myself the most beautiful of women. Therefore I am not ugly, for the effect of ugliness — its deterrent power  is nullified by money.

I, according to my individual characteristics, am lame, but money furnishes me with twenty-four feet. Therefore I am not lame.

I am bad, dishonest, unscrupulous, stupid; but money is honoured, and hence its possessor. Money is the supreme good, therefore its possessor is good. Money, besides, saves me the trouble of being dishonest: I am therefore presumed honest.

I am brainless, but money is the real brain of all things and how then should its possessor be brainless? Besides, he can buy clever people for himself, and is he who has power over the clever not more clever than the clever?

Do not I, who thanks to money am capable of all that the human heart longs for, possess all human capacities? Does not my money, therefore, transform all my incapacities into their contrary?

Who ate all the pie?

September 15, 2010

A week after Australia’s federal election, the Fairfax newspapers featured an article, “Numbers say we’re growing quite nicely“, by the economics editor of the Sydney Morning Herald, Ross Gittins. As an overview of the last few decades, this was a work of casual lustration:

The mildness of last year’s recession means the economy has now entered its 20th year of growth since the deep recession of the early 1990s. But how has this growth been distributed through the economy? […] If you imagine it’s got a lot more unequal, then you’ve been reading too many newspapers.

Gittins has been at this before, criticising the popular memory of John Howard as “the prime minister who did so much to widen the gap between rich and poor”:

But just remember: this widely held view – firmly believed by many ordinary voters as well as the ideologues of the left – exists independent of the evidence. When you trouble to examine that evidence you find the story far less damning than people imagine.

The journalist got one thing right: you shouldn’t believe what you read in the newspaper. For his argument was based entirely on coarse measures of inequality, like the Gini coefficient, derived from periodic household surveys. Due to sampling constraints, these surveys don’t capture information from the apex of the income pyramid: a tiny minority of households. They give a cut-off qualifying point for the top decile (the upper 10 percent of the income distribution, those individuals earning over $75 000 in 2007), but tell us nothing about how wealth is shared within this well-off layer.  As more income is concentrated in the upper tail of the distribution, therefore, the less useful such surveys become as a measure of inequality.

When we look at Australian taxation statistics, on the other hand, the last few decades evince – just as people imagine – a dramatic reassertion of the power and privileges of the ultra-rich. The time series below is from data reconstructed by Tony Atkinson and Andrew Leigh. It displays the share of total personal income accruing to the top 0.05 percent of the income distribution (these days some 5000 people out of 10 million taxpayers) in each year since 1941. As we can see, after declining steadily throughout the postwar decades, the income share of the super rich reversed trajectory around 1980, leaping from 0.6% in that year to around 2.5% in 2007.

A similar though less pronounced restoration occurred across the entire top decile of the income hierarchy (percentiles 90 to 100), where the falling shares of total income during the 1960s and 1970s were steadily recovered over the last three decades. But within this shared pattern, these four fractiles diverge somewhat. The higher reaches (P99-100) rose quickly and have surpassed their earlier shares. But the income share of P95-99 both declined and increased less spectacularly; that of P90-95 stayed comparatively constant.

When we add the great mass of the population (the lower 90% of the personal-income distribution) to this picture, it becomes clearer still. The series below (normalised to 1965) shows the respective changes in the share of income received by various fractiles since that year. Note the inverted U-shaped curve of P0-90, which increased its share of the income pie until about 1980, after which it declined drastically. This is mirrored almost exactly by a compensating movement in the share of the top 1%, which followed an opposite U-shaped path over this period. Note, however, that P0-90 is made up of about 9 million people, while P99-100 includes roughly 100 000 members. Income gains by the top 1% over the past three decades have been spread across a much smaller group, and therefore carry greater weight for each individual.

When, as happens sometimes, this trend of rising inequality is publicly acknowledged by economists or journalists, it is often ascribed (as our old pal Gittins did here) to “skill-biased technical change“. Innovation has favoured the “knowledge worker” and frowned upon the manual worker; their respective levels of material reward follow from this. But, as shown above, in recent decades the incomes share of fractiles P90-95 has risen barely at all. Income inequality is due not to the rising salaries of software engineers, but the engrossment of the richest within the rich. Unless we propose that top CEOs and coupon clippers possess some ineffable Trump-like skillset that the lower 99% of the population lacks, the income-follows-marginal-productivity argument is impossible to sustain.

Instead, one explanation for the divergent fates of the fractiles shown above lies in their respective income composition. P90-99 constitutes the upper-salaried layers of Australian society: most of their income (though less than for P0-90) arrives in the form of salaries or wages. The rich of the rich, however, depend more heavily on capital income (dividends, interest, rent, royalties), capital gains and partnership income.

Thus, during the 1980s, the growing income share of the uppermost percentile (P99-100) followed naturally from:

  1. skyrocketing real interest rates (from zero in 1977 to about 10% in 1989)
  2. a recovery in the average profit rate
  3. a reduction in retained profits and corresponding increase in profits paid out as dividends
  4. the subsequent increase in the price of financial assets (the influence of sharemarket spikes in the late 1980s and 1990s can be seen clearly in the income shares above).

To this list we may add cuts by the Hawke-Keating government to the top tax rate, and changes to the institutional form of the state, which was moulded to the requirements of this ultra-rich rentier layer. Price stability became the core statutory objective of the Reserve Bank; while the the Prices and Income Accord enforced wage “restraint” and a decline in unit labour costs. Lower employee compensation was exchanged for growth in the assets of union-controlled superannuation funds: the inflow to the equity market of compulsory pension savings then led to a sustained appreciation of stock prices.

Alongside the boost to capital income, one of the notable trends behind the rising income share of the top fractiles is a rise in the importance of wages and salaries.

The graph below shows that, alongside the year-to-year asset-price fluctuations that raise or lower non-salary income, salary income has risen steadily. The latter now accounts for a large portion of the income-share received by P99-100.

The most publicized aspect of this trend has been the tremendous growth of CEO salary packages (usually including stock options) relative to average wages. The function of these high salaries is – obviously enough – not to reward toil or managerial acumen; but still less is it about securing the “best talent” from competitors. It is merely the most efficient way for (1) top managers to secure a share of the surplus product, given that a large proportion of profits are distributed as dividends; and (2) owners to ensure that managers share their strategic objectives. The “wages and salaries” of top fractiles are thus, like capital income, merely another form of earnings linked to the ownership and control of assets. Where top managers do not already hold such assets, the outsized scale of executive remuneration soon transforms them into owners.

The growth of salary income in the share of the top percentile thus suggests a merger at the top of Australia’s social hierarchy, allowing the ready circulation of personnel between ownership, company boards and top management.

What, then, accounts for the stability of a social order in which a tiny minority (a few tens of thousands of individuals) has in recent decades secured such a large slice – the greatest since the Second World War – of total personal income?

For one thing, the allegiance of upper-salaried layers (P90-99) has been secured by a rise in income relative to the broad mass of the population (P90-99). For another, returns on financial investments now contribute substantially to the retirement income of this stratum, and no doubt serve an ancillary ideological purpose, linking the interests of the working rich to those of high finance.

What the unproductive parasites are up to now

September 15, 2010

So, the Grollo Empire Grocon has discovered a new way of making its insatiable desire to crowd Melbourne’s skyline with designer erections more palatable to so-called ‘left-wing greenie’ Melburnians.

Carving the portrait of one of Victoria’s most famous Aboriginal elders, William Barak, into the facade of a building at the top of Swanston Street is certainly grandiose. The building’s architectural aesthetic (gleaned from the computer image provided by the architects) appropriately confronts the conspicuous denial of Wurundjeri space and place in Melbourne (discounting tokenistic displays of “respect” during formal and informal civic ceremonies – “We acknowledge the traditional owners of the land, the Wurundjeri…”).

However, I can’t help but scoff at Daniel Grollo’s view that building a 32 story skyscraper on the former site of the Carlton and United Brewery is making “an important social statement.” The actual content of this important social statement is anyone’s guess.

Kalecki and the new Gilded Age

September 6, 2010

According to the Polish economist Michal Kalecki, capitalists ‘earn what they spend.’ The more money they throw into circulation, the more they get back as aggregate profits.

This seems counter-intuitive, but it can be proved using a simple accounting model.

First, from a macroeconomic view, total income and expenditure must balance.

The individual parties to a market transaction may view the money transferred as either a sale or an purchase, but at an aggregate level these terms refer to the same thing.

Thus in a simplified economy (no government sector, closed to international trade) we can write:

Profits + wages = consumption + investment

Consumption may then be decomposed according to class:

Total consumption = capitalists’ consumption + workers’ consumption

Assuming that workers on aggregate don’t save (i.e. wages = workers’ consumption), we can cancel a term from each side of the original equation, leaving us with:

Profits = capitalists’ consumption + investment

Even at this high level of abstraction, the model is useful. We can see from Australia’s national accounts that investment is the largest component of aggregate profits.

This can be extended to a more realistic economy (with external trade, a government that taxes and spends, and worker savings) where after re-arranging income and expenditure terms it can be shown that:

Profits = capitalists’ consumption + investment + net exports + government deficit – workers’ saving

From this accounting identity Kalecki (writing in 1942) drew clear conclusions:

It is from this point of view that the fight for foreign markets may be viewed. The capitalist of a country which manages to capture foreign markets from other countries are able to increase their profits at the expense of the capitalists of the other countries…

In a sense the budget deficit can be considered as an artificial export surplus…

The above shows clearly the significance of ‘external’ markets (including those created by budget deficits) for a capitalist economy. Without such markets profits are conditioned by the ability of capitalists to consume or to undertake capital investment…

The connection between ‘external’ profits and imperialism is obvious. The fight for the division of existing foreign markets and the expansion of colonial empires, which provide new opportunities for export of capital associated with export of goods, can be viewed as a drive for export surplus, the classical source of ‘external’ profits. Armaments and wars, usually financed by budget deficits, are also a source of this kind of profits.

Thus the trade surplus of present-day China constitutes a huge boost to the profits of Chinese firms.

But what of those countries  like the US, UK and Australia  where investment is relatively low due to inadequate rates of return, and which import much more than they export?

Here Kalecki’s equation has a further implication. Profit may be maintained by unproductive expenditure, luxury consumption and state deficits.

Splurging on yachts and private jets, rather than being a deduction from profit, contributes to it.

This is made clear when, turning to the Australian national accounts, we observe how the components of profits have changed over time. First we need to find numerical values for the terms in our profit equation.

Profits = capitalists’ consumption + investment + net exports + government deficit – workers’ saving

But in national accounts, consumption and savings aren’t decomposed according to class. The term for capitalists’ consumption and workers’ saving will thus be a residual, calculated by subtracting the other components of profit (investment, government deficit, net exports, etc.).

We can see below how the relative contributions of investment and the residual term (capitalists’ consumption minus workers’ savings) have changed in recent decades.

Investment still makes by far the largest contribution to profits, but the importance to aggregate demand of capitalists’ consumption and working-class indebtedness has steadily risen.

The popular depiction of the wealthy elite  acquiring their riches through deferred consumption, thanks to discipline, frugality, and genetically-endowed low time-preference rates  has changed accordingly.

The notorious Citigroup equity-strategy reports of 2005 (part one and part two) may stand as ideological bellwethers.

There a curious, adventuresome ‘new wave of entrepreneurs and managers’ with elevated dopamine levels is exhorted to ‘commandeer a vast chunk’ of social wealth by ‘paying itself a lot.’ The ‘Anglo-Saxon plutonomies’ (US, UK, Canada and Australia) are lauded for uncovering new ‘dominant drivers’ of aggregate demand. Thanks to the luxury expenditure of a ‘new Managerial Aristocracy’, ‘toys for the rich’ account for a disproportionate slice of consumption. Like it or not, the ‘earth is being held up by the muscular arms of its entrepreneur-plutocrats’, not ‘the multitudinous many’.

As the authors conclude, ‘if the rich keep getting richer, as we suggest, this bodes extremely well for businesses selling to or servicing the rich.’

Open support for this spendthrift upper stratum is the declared outlook of the Australian state elite, as is smug complacency about its Titan’s long-term creditworthiness. Treasury and Reserve Bank personnel have lately begun referring to a merely ‘North-Atlantic Financial Crisis‘, and the central aim of the new Australian government is, in the words of the Prime Minister, to secure the ‘stability and continuity’ of the pre-2007 growth model.

Mass unenthusiasm for this bipartisan project (and its agents) has been spun ingeniously by media and state leadership. Following the recent federal election, members of the ruling elite claim to have ‘heard a message’: ‘the Australian people, given the closeness of this vote, want us to find common ground’.