Tuesday, December 1, 2020

Basic difference between wage inequality and income inequality studies

 I recently wrote in the anticipation of the arguments I will make in my forthcoming book that the period 1970-2000 was extraordinary barren in Western economic studies of inequality. It was similarly empty as regards inequality studies in communist economies. Only in Latin America was the situation different.

Some people objected to this by pointing to a significant number of wage inequalities papers produced in the US and elsewhere. There are indeed many them.  There is also a very successful book by Claudia Goldin and Lawrence Katz  “The race between education and technology” that takes its cue from Tinbergen’s 1970s writing on the education premium and his expectation that the premium to college education would go down to zero due to a high supply of university-educated people. It is not my topic here to discuss why this did not happen, or rather why the opposite, the increase in returns to education, occurred in the United States and elsewhere. What I want to show is that studies of wage inequality cannot be taken as equivalent to what we ideally expect from the work on income inequality. There are two reasons for this: technical and ideological.

Let me start with the technical. When we observe, for example, an increase in wage inequality and calculate all relevant statistics, whether it is driven by increased wage inequality among women or men, Blacks or Whites, more educated or less educated, we still know nothing about household formation. It could be that high-wage workers marry low-wage workers or the reverse. Or that they marry capital-owners or the unemployed or people outside the labor force. Or that many wage-earners do not partner at all. Each of these possibilities has significant and very different implications; yet they are, by the very nature of the topic, entirely unaddressed. The units in wage inequalities studies are different from units in income inequality studies: individual workers vs. households (I will explain below why this is of crucial importance).

Additionally, wage studies leave out large chunks of what makes inequality: they leave out “income without work” which comes from property (dividends, interest, rents), capital gains and losses, and the entire system of redistribution through direct taxation and government cash and in-kind transfers (e.g. Social Security benefits and SNAP, formerly known as food stamps, in the United States). They also leave out self-employment income, home consumption (i.e. own produced and consumed goods and services), and imputed income from housing, all items of crucial importance in middle-income countries. Wage inequality studies are even of lesser relevance for poor countries where formal wages often represent 1/3  of total income.  

In other words, wage inequality studies deal with the distribution of income from one factor of production (labor) among wage-earners—which is indeed important—but ignores everything else: (1) the other factors of production, capital and land, which because of their concentration among the rich are often the most important determinant of inequality, (2) the entire system of government redistribution, (3) self-employment income and home consumption, and (4)  family formation.

But the principal problem is that they miss why we care about inequality in the first place. Inequality is created and reproduced at the level of household not at the level of individual wage-earner. It is total household income, adjusted for the number of individuals, that makes families rich, poor, or middle class and imparts them corresponding values. The socialization is done within households not within (whatever it may mean) individual wage-earners. It is the processes of mating, household formation, as well as contribution of other sources of income that create rich or poor households, social classes, and most importantly, by differentiating opportunities at birth, allow for the reproduction of social inequities.

We study inequality because we care about social classes and their ability to transmit advantages across generations and create self-sustaining “aristocracies”. The concern with returns to schooling is surely one of the issues, but far from the most important. (The importance of wage studies is greatest in matters such as union premium or determination of CEO pay.)  People who care about inequality are equally concerned about social factors that make access to education uneven as about the fact that the returns to schooling may go up.  

Wage inequality studies belong to the area of labor economics. It is an important, but subsidiarity, field to inequality studies. Their position is similar to that of wage studies as affected by trade. The latter belong to trade economics, not to inequality studies.

Conflating studies of wages, whether from labor or trade economics, with studies of inequality is not only inaccurate. It displays a profound incomprehension of why we care about inequality and what is the real objective of such work: figuring out the fundamental determinants of class structure and its effects on politics, behavior and values, and transmission of such characteristics across generations.

Tony Atkinson in his 1975 “The Economics of Inequality” did not survey Tinbergen's wage inequality work. In his 1997 review article, he wrote: “It is indeed striking how much the recent discussion has focused exclusively on wage differentials and not asked whether such differences are associated with [income] inequality” (Economic Journal, 1997, p. 311).  Rawls likewise thought that while inequality has to be limited both in terms of capital and labor incomes, the key concern ought to be with inequality of overall income and household-driven reproduction of such inequality.

It is important that the logic and the objectives of inequality studies be correctly understood. Such studies are at the intersection of economics, politics and sociology, and perhaps anthropology.  Not understanding it correctly is likely to lead to many mistakes.

Monday, November 30, 2020

Florian Lavit: Critical comments about the concept of citizenship rent in "Capitalism, Alone"

 

A new use of the outsider’s perspective literary trope

 

In his new book, Capitalism, alone, as in his previous best-seller about global inequalities, Branko Milanovic successfully casts a new light on seemingly self-evident economic phenomena in a quite unsettling way. One could assume that this surprise effect is as much a consequence of his analysis as an intentional goal : they are, in my opinion, an integral part of his method. There is no doubt that this intellectual approach is utterly justified since it is, I think, an essential path to any conceptual discovery. Besides, such a method is reminiscent of the old narrative trick of the foreign man’s perspective which Montesquieu or Camus readers might be familiar with. Capitalism, alone is in many ways evocative of the Persian Letters. One could mention, for instance, the part in which communism is described as a cunning of reason whose real finality was to help those countries which were dominated by the West establish their own endogenous form of capitalism. This also true of the passages about the citizenship rent which I will discuss later. However, this method has its limits, and as must now be clear, I object to Branko Milanovic’s questionable analogies whose logical consistence isn’t fully verified.  

 

Individual inheritance and collective inheritance: the missing macroeconomic link

 

The original concept of citizenship rent, already explained in Milanovic’s previous book, is explored more thoroughly in Capitalism, alone. It is no doubt one of the author’s most important theoretical contributions and, in my opinion, a very fascinating and irritating perspective at the same time. Milanovic uses several analogies to make this concept more understandable or, perhaps, more appealing. The parallel I want to address is the one he draws about inheritance. Citizenship rent is viewed as a sort of inheritance: for Milanovic there is no difference between the individual wealth transmitted to another individual and the national prosperity which, according to him, is also transmitted. The idea sounds engaging since, as he reminds us, one does not deserve his parents’ wealth anymore than he does his country’s prosperity.

 

There is no denying this is an intellectual tour de force, and after first reading it, I did not know how to disprove this comparison even though it felt wrong. Upon second thought, however, the analogy appears invalid: an heir can be replaced by another individual heir without the assets he will inherit being altered, but a whole national population due to “inherit” the country’s wealth could not by fully replaced by a different one without said wealth to be destroyed in the process. The right way to pass from micro to macro level is the following:


 

 Milanovic’s conceptual mistake is that he puts micro and macro level together so that he obtains the following, fallacious, equation:

 

 This type of conceptual mistake is a fallacy of composition.

 

New parallel, same missing link

 

 Such a fallacy of composition is at work in the analogy between the surplus revenue in certain countries (relative to others) and monopolistic unearned income. The latter depends neither on the beneficiary’s qualifications nor his contribution. An individual with a monopole on raw materials may be replaced by another with no impact on the production level. In order for the analogy to be correct, one would have to replace an entire population benefitting from this alleged “monopole rent” with another one, and see if the production remains unchanged: this is obviously not the case.

 

The analysis must distinguish between two kinds of assets

To fully grasp this idea, one must understand the difference between two types of assets. On the one hand, some assets do not depend on who owns them, and their value is unchanged when the owner changes. On the other hand, there is another category of assets whose value and permanence strictly depend on their owner. The owner’s identity cannot be changed without the asset being altered or destroyed. The whole range of knowledge and skills that prompt the prosperity of a country are its intangible capital. Its reproduction requires constant learning and application by the nationals, so that an integral replacement of all the « owners » would effectively destroy this capital. If all the inhabitants of country A were to be replaced by country B citizens overnight, there would remain little or nothing of country A and all its so-called monopole, i.e. the productivity and skills of the people living in it, would be gone.

 

Summary and perspectives

 

To summarize, if a possible heir dies, the inheritance remains, but if the possible « heirs » of the intangible capital of a country disappear, the collective inheritance goes away. This means that at the macro level, the heirs and the inheritance interact and shape one another, while this is not the case at the micro level. This macro law is just as valid for inheritance taken in a metaphorical sense, as a set of knowledge and skills, as for a literal inheritance. Indeed, in the latter case, the sum of the inheritances can only be brought about by the entire population: A can only keep his inheritance thanks to the skills of B, and vice versa. This is a solid ground for a critic of individual inheritance, which fails to take into account this social dimension. One might even, in a more polemic tone, describe this custom as the continual privatization of a country’s prosperity.

 

In the end, one could pivot Milanovic’s logic and make a point that some countries are privatizing the world’s prosperity. I believe it would be the best way to avoid the fallacies of composition we previously encountered and to give a solid foundation to his « methodological globalism ». Such a perspective would probably lead to point how parasitical the United States’s position is, whether through their martial use of the dollar or the draining of the intellectual resources of the world. All of this leads to reconsider migration issues. According to Milanovic, the best way to eliminate or at least mitigate the citizenship rent is to allow more migrations, but according to my new approach, it deepens the privatization of the world prosperity by certain countries. However, I don’t believe this objection is decisive. The following objection, on the other hand, is: migrations should be dealt with, above all, from a political standpoint, not an economic one. Ultimately, the last and more important point is a very neglected sort of moral hazard: if an individual is expected to give anything to his community, the community must in return commit to protecting the individual. Exponential migrations break this social contract.

 

 

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Note: The text was originally written in French and translated by Florian Levit and Elsa Domergue. It was part of an email discussion between Florian and Branko. Florian Levit teaches literature at a Lycée in Le Mans. His interests include economics, in particular authors such as Michal Kalecki, Josef Steindl, Alec Nove, Fred Hirsch.