On unproductive labor

Today I read an article on shortages and economic collapse in Venezuela. The reason why there are huge lines in front of the stores was the same known to any student of socialist economies: state stores sell heavily subsidized goods and the demand for such goods exceeds their supply. Then, many people buy much more than they need and engage in selling the goods at higher prices to those who are either sufficiently rich to pay higher prices or who have been unlucky that the supply ended before their turn came.

The buyers and resellers of such goods in Venezuela are called, according to the New York Times, bachaqueros.  Ricardo Hausmann, from the Kennedy School at Harvard who was Venezuela’s planning minister in the 1990 was then quoted by the New York Times as saying: “This is the crazy thing about the system. A lot of people are putting in effort [to buy the goods and resell them], and none of that increases the supply of anything. This is perfectly unproductive labor”.

That statement made me stop. “Perfectly unproductive labor”? But that “unproductive labor”, as every economist knows, improves the allocation of goods. The goods flow toward those who have greater ability to pay and since we tend to associate greater ability to pay with greater utility, the goods, thanks to bachaqueros’ activities, are better allocated. If one argues that bachaqueros activity is unproductive because it “does not increase the supply of anything” then one should argue that the activity of any trade or intermediation is unproductive because it does not produce new goods, but simple reallocates. The same argument could be used for the entire financial sector, starting with Wall Street. The entire activity of Wall Street has not produced a single pound of flour, a single loaf of bread or a single sofa. But why we believe that financial intermediation is productive is that it allows money to flow from the places where it would be less efficiently used to the places where it would be used more efficiently. Or for that matter from the consumers who cannot pay much to the consumers who can. Exactly the activity done by bachaqueros.

Hausmann’s view is identical to the (falsely) Marxist view of productive and unproductive activities reflected in socialist countries’ national accounts, called Material Net Product. Socialist countries’ approach was that all services (including health, education and government administration) were unproductive because they did not produce new physical goods. Obviously, speculators like bachaqueros were the very epitome of unproductive, and even (it was held) “socially noxious” or “abhorrent” labor. This view had practical consequences for the calculation of national income because the level of national income in socialist countries was underestimated, compared to what it would be according to the UN’s System of National Accounts, but the rate of growth was overestimated because productivity increases were generally greater in production of goods than in services.

Marx had a distinction between productive and unproductive labor which was more sophisticated. Productive was all labor that resulted in the production of the surplus value. Thus, Marx in a well-known example, shows that a singer (a prototype of activity that does not produce anything tangible) is engaged in productive labor so long as he is hired by a company or an individual and creates profit for his employer. In Marx’s view productive-unproductive dichotomy was not given forever but changed depending on socio-economic formation. The problem with socialist governments in Eastern Europe was that they had trouble deciding what should be productive and unproductive according to Marx in a socialist society and took the easy road to declare unproductive whatever activity did not produce tangible physical goods.

There was also a  categorization introduced by Ann Krueger in the 1970s who defined the so-called “directly unproductive activities” or “rent-seeking activities”. The idea was to classify under such heading all activities whose objective is to extract some government concession that would result in higher incomes  for those successful in lobbying. Pharmaceutical and IT companies that pay hundreds of K Street lobbyists in Washington today would fall under that category—even if Krueger’s classification was originally intended mostly to push developing countries’ governments to be less interventionist (was directed especially against “India’s Licence Raj”;  see Bhagwati here). Lobbying was, it was argued, unproductive because it led to the creation of rents. And rent is, of course, an income that can be taken away without affecting the supply and allocation of goods.

Finally, it leads us to the topic of theft. It is not easy to put theft in its right place in economics. Theft for private use can be justified by arguing that the bread stolen by a poor person from a rich one is almost certain  to increase the amount of “social happiness”. (I have often thought of that in New York where that the old-fashioned idea that one should keep $20 in his/her wallet to give it to a mugger certainly made sense in helping "the greatest happiness for the greatest numbers"). The issue is more complicated when we come to theft for resale: burglary of a jewelry store and resale of the jewels might increase overall welfare if burglars are very poor and jewelry owner very rich but it cannot be defended on better allocation grounds because the jewels could have been equally accessible to those who wanted to buy them whether they are sold by the owner or by thieves.

The issue of preventing theft leads us to yet another category of labor that can also be considered unproductive: security personnel or what is  called the “guard labor”.  Their salaries are paid in order to prevent theft. They clearly do not increase the supply of goods, nor do they improve goods’ allocation.  The only defense that their labor does produce something is in the argument that prevention of theft improves protection of property which makes for more investments and increases long-term growth. But this is,  as can be seen, a rather more convoluted justification, which by the way, can be also used to argue why theft, even if it might improve short-term welfare, is likely to be pernicious in the longer-term, a point of view that goes back to Adam Smith.

Deciding for a capitalist economy what is productive and what is unproductive labor is not always easy. How much more difficult if we study economic history: how to classify monks and priests when they are paid by legally compulsory tithes; Robin Hood could be defended on the maximization of utility principle but criticized as inimical to long-term growth; Francis Drake stole goods owned by the Spaniards who extracted them by using forced labor…

Economic reflections on the Fall of Constantinople

This Sunday, May 29 marks the anniversary of the Fall of Constantinople in 1453. I have been recently reading (and in some cases, rereading) books on the last period of Constantinople, after the reprieve of 1402, brought about by the Ottoman defeat by Tamerlane, and how and why this period was not better used. But thinking of Roman Empire and of what is called (somewhat inaccurately) Eastern Roman Empire, led me to two, I hope interesting, observations.

First, why the Industrial Revolution did not happen in Eastern Roman Empire? Asking this question is  going back to the famous query posed by Michael Rostovtzeff in the 1930s: “Why was there a detour of some ten centuries; why did not seemingly modern-looking market institutions of Rome produce at least a Lombardy-like economic development, not in the 14^th but in the 4^th century?” There are many answers to that question. From those who emphasize external factors like the “barbarians at the gate” to those who, like Rostovtzeff himself, believe that the weakening and the break-down of the Empire came because of its inability to incorporate lower classes and because of the “dead hand” of a rising military bureaucracy;  to those like Marx and Aldo Schiavone and Bob Allen who believe that the culprit was slavery:  cheap labor that provided no incentive for the use of labor-saving machines that technically could have been developed.  Finally, there are those who in the debate between the “modernists” and “primitivisms” thought, like Moses Finley and Karl Polanyi, that Roman institutions did not contain at all the seeds that could have led to capitalist development.

Where does Eastern Roman Empire come into that discussion? It seems to me that the most appropriate answer to Rostovtzeff’s question would be to look to the “country” about which he posed the question: the country that was the continuation of the Roman Empire, nay that was the Roman Empire itself (Constantinople become the capital in 330 AD, some 80 years before the first sack of Rome) and that lasted for another 800 to 900 years with no interruption. (That is, if we want to date the end of the Roman Empire in 1204 when Byzantium was conquered by the Crusaders).

Wasn’t there enough time to find out if ancient institutions could become capitalistic? Eight or nine centuries seems plenty. Moreover, what, culturally and institutionally, better place to develop than the Eastern Empire: direct continuator of the larger Roman whole with an educated elite, same institutions, stable currency (solidus, “the dollar of the middle ages”), reasonable protection of property rights, people knowledgeable of Greek and Latin and thus able to read everything from Herodotus to Columella’s agricultural treatises without the intermediation of translation, with Roman laws codified and simplified by Justinian. Why did not there develop “bourgeois virtue”, “inclusive institutions”, Landes’ “culture”?  Or does it all have to do with “serendipity” of having coal and expensive labor in one place? Yet despite all of these advantages, no one reading the history of the Eastern Roman Empire would come thinking that there was any chance of it developing in the capitalistic direction. It was as feudalistic as they come.

I do not know why market economy with wage labor failed to develop there and can only speculate that it might have been because of a militarized bureaucracy, land magnates (and thus high inequality), obsession with Christian theology which sucked the best minds into sterile disputes (it would be nice to have an anti-Christian like Gibbon tell us why the Eastern Empire could not become a capitalistic power!), its frequent wars with Arabs, Persians, Russians, Normans, Bulgars, Pechinegs, Avars, Ottomans… Any other candidates?

There is plenty of recent scholarly work on why China failed to become capitalist and start the Industrial Revolution (for an excellent discussion  see Peer Vries “Escaping poverty”, and especially the chapter entitled “Why it does not make sense to call Qing China capitalist…”), but it seems to me that equally revealing and rewarding would be to study why the  Eastern Roman Empire, seemingly full of all the necessary prerequisites, failed to do so. The ingredients were present in both China and Eastern Rome, but in neither case did development occur: why?

The second observation has to do with trade and war. The reading of Eastern Mediterranean history is extremely instructive  for a way in which we should think of trade. A benevolent approach, starting with Ricardo, always regarded  trade as an activity freely undertaken by two parties with no extra-economic compulsion. No reader of history of the Eastern Roman Empire can share that view. Trade and military underpinning of it went hand-in-hand. This is at its most obvious not in large empires which anyway had to have armies but in trading city-states like Venice and Genoa. If you believe that trade is all about peace there would be no reason why these city-states had to maintain large naval fleets, fight battles, conquer islands, negotiate, under military threat, special rights to tariff-free imports and exports. Trade, debt and the army always moved together. No tourist to any Greek island today will fail to observe large Venetian  and Genoan fortresses that could not have been built without money and labor but also without a naval presence that allowed the control or conquest of the islands in the first place.

When the Fourth crusade started, the first city to have been sacked by the Crusaders was a Christian port-city of Zara (today’s Zadar in Croatia), a rival to Venice. The doge paid the Crusaders to start their path of destruction with a city populated by their co-religionaries. The association between trade and war which continued throughout the rest of history, and certainly throughout the 19^th century, helps us to have a much more clear-eyed view about colonialism too.  As said by a Dutch Proconsul in Batavia in a letter written to the Directors of the Dutch East India Company (that I cite in my recent book),

Your Honors should know by experience that trade in Asia must be driven and maintained under the protection of Your Honors’ own weapons, and that the weapons must  be paid for by the profits from the trade, so that we cannot carry on trade without war nor war without trade.

Trade followed the flag in Africa and Asia (Leif Wenar and I wrote an article on that criticizing Rawls’ rather quick acceptance of the “doux commerce” view of trade).  “The unequal treaties” with China would be unimaginable without European military superiority and the threat it implied; the Opium War—another example of the close association between the two—was won by arms.  “Free trade” came to India and Africa “out of the barrel of a gun”.

Trade, helped by arms, was often at the origin of the fortunes which grew further by monopolistic or monopsonistic  practices, lending or usury, or in some cases through entrepreneurship. The origin of fortunes was thus often extra-economic. But that need for military power, if one wishes to trade and be rich, is best seen on the example of trading city-states that, in a world without coercion and ruled by the benevolent comparative advantage, would not require fleets, cannons and mercenaries.

History is useful---even for economists.

PS. The electoral/referendum season is upon us, so tempers flare, and I should explain more clearly my own thinking on trade and war. When Leif Wenar and I argued that trade and war are linked, we took a position against a somewhat naïve and mechanistic view (shared by Rawls) that liberal peoples who trade are necessarily peaceful. Indeed, military power was often used to extract advantages in trade or simply to pillage weaker nations. But that does not imply that military power is always used for that purpose. Sometimes, as in the US control of today’s shipping routes in the Pacific or Pompey’s campaign against the Cilician pirates, the military underpinning is needed to make trade and development possible.  There, arms play a role similar to domestic monopoly of violence which guarantees  property  rights and human rights more generally.

Why “Make America Denmark Again” will not happen

The rise of inequality in rich countries is way over-explained. Because income inequality (evaluated at the level of households or individuals) is such a complex variable, outcome of a vast number of technological, political,  demographic and behavioral factors and its neat decomposition into these various factors is impossible, we shall always have a plethora of potential explanans. This was a point nicety raised in a recent post by Chico Ferreira from the World Bank.

But not all explanations are equally powerful or make sense. A couple of days ago at a conference at Northwestern University, I listened to the explanation proposed by Gerald Davis from University of Michigan. Davis argued, at first very counter-intuitively (so much so that at first I thought I misunderstood his point), that the rise of US inequality coincides with the decline of large companies that used to employ hundreds of thousands or even millions of workers and by their substitution by much smaller companies. As shown in a graph from Davis and Cobb (“Corporations and economic inequality around the world”, 2010) the share of large employers in total US employment went down simultaneously with the increase in US income inequality. (What Davis and Cobb call the “ratio of top 10 employers to labor force” is, I suppose, the percentage share of all US workers employed by ten largest companies.)

Why did it seem counter-intuitive? Because there is an earlier influential literature going back to Herbert Simon and Thomas Mayer that saw the behemoths of the 1960s with their heavy hierarchical structures as precisely driving inequality up. The more ladders you have in a hierarchical structure, the more pay grades there are, and the more likely are the top managers who lord it over thousands of employees to have high salaries. Hence greater inequality. At least that was the theory.

But Davis argues the opposite (and was helped by the data that go this way). His argument is that large hierarchical structures have to engage in some evening out of salaries (internal redistribution) in order to keep cooperation, needed for the success of the enterprise, going. On the contrary, if the big bureaucratic machines get divested, and jobs hitherto performed within company get outsourced to different contractors, there is nothing to keep the new small, lean and mean company from extracting all the surplus from each and every contractor the way that Amazon is  credited (or “credited”) of doing it.  So take a General Motors and break it into thousands of independent companies producing components, then outsource cleaning, marketing, food catering and legal services, offshore accounting and customer relations, and you end up with today’s enterprise structure. Those who have remained at the core can pay themselves huge salaries since they do not depend on the goodwill and cooperation of the outsourcing companies. If the accountants in Chicago feel they are paid too little, GM will gladly hire accountants in  Calcutta.

This is basically, I think, Davis’s idea (and I hope I presented it accurately). But my explanation for this change went, I thought, one step further. I think that the deconcentration of which Davis  writes is only a proximate cause of the rise in inequality. The “deep cause” was technological change, combined in an inextricable way (as I argue in my “Global inequality”) with globalization. What happened, I think, was that advances in technology such as stock management (just-in-time), ability of speedy “bespoke” production, and crucially advances in telecommunications made “broken up” (devolved) production more efficient. The concentration of workers in one place that, at the origin of the Industrial Revolution, was made indispensable by the importance of the energy sources available at discrete physical points, could now be reversed. We could go back to a type of production that predates the Industrial Revolution, a kind of a modernized “putting out” system.

In doing so companies were helped by globalization because the area over which the putting out system can now extend was the globe itself, not only villages 10 miles in perimeter from Manchester.  Only then, all the elements mentioned by Davis, could follow. The companies did not need to ensure the collaboration of employees by  dint of redistribution of some profits across the labor force. The broken-down units were too small to allow for any meaningful unionization, and the trade union density declined.  Further, there are no labor conditions to negotiate with a company to which you sell your goods or services. At the extreme, imagine a structure where the core company divests practically all tasks to companies composed of one individual each. Inequality within each company will be zero while total inequality could be quite high (because between-company differences in average wages will be high).

My view is indeed one that may be called “technological determinism”, but that determinism is playing itself out on an ever expanding field made possible by globalization.  In other words, technological determinism is itself a function of globalization (heaving off some activities clearly could not be equally efficient in a world where you had to hire US workers only) and technological determinism in turns helps globalization. So the two go together. Moreover even things that seem to be policy-related (say, decline of trade unions) may in many instances be driven by the combination of new technology and globalization.

It is for that reason that I am skeptical that “the happy days of the 1960s” will ever come back. This is the idea that  I somewhat jokingly called “Make America Denmark  Again”. That world made sense with the technology and the policy as it was in the 1960s but not today. The world of large-scale manufacturing, homogeneous working class, trade unions, capital controls and a quasi-closed economy (US exports and imports combined were less than 10 percent of American GDP in the 1960s; they are more than 30 percent today) is over. When we think of how to address inequality today we should move from the ideas that worked half-a-century ago.