Sunday, July 12, 2015

What is the Inequality for Our Age?

The article, "To Each Age Its Inequality," presents a concept that in broad outline reflects my own view. Underlying economic conditions lead to differing levels of inequality being efficient giving differing economic conditions. The key concept is this:

So, just as in the farming and foraging worlds before it, our fossil fuel world has a “right” level of inequality, and societies that move toward it will flourish, while those that move the other way will not. Successful governments know this and apply taxation and other measures to push economic inequality toward what they hope is the sweet spot.
However I have a major problem with the next passage:

The big question, of course, is just where this sweet spot is. By 1970, the Organization for Economic Cooperative and Development nations had driven post-tax income inequality down into hunter-gatherer territory, averaging just 0.26 on the Gini scale. The economic difficulties of the following decades, however, suggest that this was perhaps too low. Most people apparently thought so, electing governments in the Reagan-Thatcher era that allowed the rich to keep more of their gains.
My issue with this is that while we can be fairly confident that over the millenia agrarian societies had plenty of time to reach their equilibrium levels of inequality the same cannot be said for modern ones. While powerful groups did an excellent job selling low inequality as a source of the problems of the 70s the economic history that I've read focuses on other factors, primarily the oil shock and the beginnings of adjustments to globalization. It does not follow from the fact that various groups in favor of higher inequality successfully sold their ideas to the public that this was in fact the correct diagnosis. It may or may not be, but we lack the evidence to call this one accurately and this particular observation is basically irrelevant to the question as to what inequality is in truth demanded by our age.

To get at this, I suggest we should explore the concept a bit more deeply, and think about what underlying economic factors drive the variance in efficient levels of inequality. This is straightforward enough for pre-modern agrarian societies. Everything I've read on this topic is in agreement that inequality arises because the variance in the productivity of the land is far greater than the variance in the output of individuals. Some societies tried various schemes to reduce this inequality, such as periodic rotation of fields between households, These societies proved less successful because of a second factor, while land could be improved rates of return were very low for investments in early periods. To create incentives for long term investment it was necessary to make land holdings perpetual, if a household could pass down the improvements to subsequent generations then the investment looked more attractive then if the land was likely to be redistributed at some future point. Since the variability in an individual farmer's skills were less important than the variability in the land itself it was inevitable that highly unequal societies would emerge.

The above is of course vastly oversimplified but it is far more difficult to tell a similar story for the modern world. We are still faced with the fact that human ability just doesn't vary that much, while some individuals can pick things up quicker than others with enough time most humans will perform most tasks with relatively similar ability.* Another factor is that unlike with land most plant and equipment used in the modern productive process can be replicated, there isn't a similar dynamic with land where high variance in the productive qualities of plant and equipment would lead those that have it to get high returns.

Since it can be taken as a given that any firm could acquire both people and the plant and equipment necessary to perform economic tasks with similar efficiency as existing firms we are left with intangibles as being the driving force behind the efficient level of inequality. Firms do differ with respect to their internal culture, the efficiency of their organization, and factors such as reputation and market position. These are the factors that lead firms that are otherwise similar to experience greatly different returns. The question that arises is what does this imply for the efficient level of inequality? In my opinion, I see the differences as arising primarily from the bottom up, emerging from the solutions reached by workers within the firm to gradually become institutionalized in the practices of the firms they work for. But this is contained within structures of property rights which evolved to create incentives for the development of land in agrarian societies, with something of an overlay to encourage agrarian land owners to transition their wealth into property, plant, and equipment instead of agricultural land, and not to create incentives for the development of the intangibles necessary for success in the market.

Given the extent to which our property laws continue to resemble those of the agrarian era rather than those that would create incentives for those traits needed in modern market economies, my view is that current property laws tend to lead societies to have much greater levels of inequality than would be ideal for a market economy. While competition between societies is resulting in some experimentation towards more efficient forms of organization they power granted by current law allows those with that power to exploit openings, such as the economic turmoil of the 1970s, to reassert their historical dominance and roll back the evolution towards more efficient forms of economic organization. Over time, competition between societies will decrease the power of these groups but this is likely to be a very slow evolution, just like the transition from the egalitarian world of the foragers to agrarian societies was very slow. But I see power structures that give outsize influence to owners to be essentially similar to that of agrarian societies that tried to rotate their fields to make people more equal, an inefficient set of institutions that will cause these societies to decline and to eventually be replaced by societies that recognize that underlying economic conditions have changed and that society must reflect the underlying more egalitarian requirements created by modern systems of production if they are to flourish.

* I realize this is a fairly strong statement, and there are obviously tasks where some trait is hugely beneficial, but most workplace tasks are of the type that any individual performing them repetitively for a long enough period of time will perform similarly. Of course, since some tasks are valued far more than others those that take to them easily will tend to get the high valued tasks to perform and leave others for the lower valued tasks; opportunities are just never given for these slower individuals to perform high value tasks.

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