Inequality: power vs human capital

David Ruccio points to labour's falling share of income in the US and says:

We need to talk much more about profits and who owns capital. And, in addition, who appropriates and distributes the surplus and to whom that surplus is subsequently distributed.

This is like saying a man should put his trousers on before leaving the house.It's good advice, but it shouldn't need saying.

A nice new paper by Amparo Castello-Climent and Rafael Domenech at the University of Valencia supports his point.

They point out that there's no correlation between inequality of human capital and inequality of incomes. This is true across time: since 1950 human capital inequality has fallen in most countries but income inequality hasn't. And it's true across countries; many Asian countries have quite high inequality of educational achievement but low income inequality whilst south America has unequal incomes but relatively equal human capital.

This is a challenge for the neoclassical view that income inequality is due to inequality of marginal productivities.

One might try and rescue the marginal productivity story by arguing that the return to primary education is low and that to university education has risen because of skill-biased technical change, so that a rise in human capital equality because of higher basic skills is compatible with rising inequalities of marginal productivity. However, other research suggests this story isn't true; the returns to basic skills are quite high, and changes in inequality are loosely linked to changes in education.

Instead, the more obvious possible reason for the lack of link between human capital and income equality is simply that inequality reflects not differences in productivity but differences in power which themselves arise from institutional differences.Inequality is higher in south America than in Japan or South Korea simply because south America has extractive institutions which enable a small minority to exploit the masses, whereas Japan and South Korea do not.

Institutional differences in power also help explain another fact: why does the return to university education differ so much (pdf) across European nations of similar income? It is higher in the UK than in Germany or Nordic countries, for example. It's hard to explain this by technical change or globalization, as these factors should have affected countries reasonably similarly. A more plausible possibility, surely, is that institutional factors - the power of capital over labour - allow (some) graduates greater access to the economic surplus in the UK than it allows them in the Nordic countries.

Although I'm speaking here in macroeconomic terms, the point holds at a micro level too. Why did Rebekah Brooks get a £10.9m payoff from Murdoch? It's not because she has obvious greater marginal productivity or technical human capital than the rest of us. It's because (for reasons we needn't consider) she had privileged access to the surplus.

Inequality, then, is better explained by power than by human capital or marginal productivity. 

Comments

[UnlearningEcon]

It is worth noting that marginal productivity - among its many flaws - has the problem of being indeterminant for labour or capital alone. For example, what is the marginal productivity of a taxi driver without his taxi? Or an office worker without his computer?

This ties in with the bargaining power story. Since things can only be produced by labour and capital together, it makes sense that the distribution of this product would be determined by bargaining power.

[Robertnielsen21.wordpress.com]

Agree. Economics is determined far more by power than by supply and demand.

[UnlearningEcon]

Sometimes I think 'supply and demand' is another way of saying 'bargaining power.' For example the measure of unemployment obviously impact's labour's bargaining power, but this can also be shown by a supply curve.

[Alex Marsh]

Agreed that we need to take power much more seriously. Some of the work by Bowles and Gintis from a while ago was arguing strongly for the need to give short side power much more attention. I'm currently reading Haring and Douglas' recent book "Economists and the Powerful: Convenient theories, Distorted facts, Ample rewards" which is largely about how power got squeezed out of economic thought. Their main point is that it wasn't an accident that we moved from a political economy concerned with distribution to a marginalist mainstream that has banished both power and inequality as respectable subjects for discussion. It was the product of actions by powerful (mostly US) economic actors.

[Bill Gardner (@Bill_Gardner)]

Completely with you that power is huge. And that reducing inequality will require a power shift.

But imagine that you were a benevolent dictator. Would you just redistribute income? Wouldn't you also equalize access to health care, exposure to environmental toxins, access to education, and so on? Inequality in human capital and marginal productivity is endogenous, but it matters.

[Luis Enrique]

UE it just depends on your production function. If you use Cobb Douglas and K=0 then output is zero and marginal product of labour is defined, at zero. If you have a production function in which output may be produced with labour alone, then MPL is whatever it is.

Not for first time, I can't resist: you should have learnt some more economics before you started unlearning it.

[Luis Enrique]

I'm never quite sure what counts as neoclassical and what doesn't. If it means perfect competion, factors paid marginal products, clearing markets, then nobody thinks that describes labour markets, although many people think useful work can be done maintaining those assumtions, like for instance
http://afinetheorem.wordpress.com/2012/12/11/the-human-capital-stock-a-generalized-approach-b-jones-2012/

is perhaps worth noting that mainstream labour economics, mortensen pissarides matching models, at based on bargaining over the surplus of production.

People often say mainstream econ ignores power but I reckon it often models power just under a different name. For instance, pricing power. Or principal and agent. And what is bargaining power if not having a skill much in demand? I agree there are aspects of power not catered for in simple models, but also I think the distinction between power and, loosely speaking marginal product explanations, are not as sharp as all that. For example, if you want to understand bargaining power then you need to think about outside options, and you probably need to invoke some concept not a million miles from marginal productivity to explain that in many cases. An exception being, I think, if your are a member of the gilded club of senior executives.

[Luis Enrique]

Badly written. Having a skill much in demand is one instance of bargaining power, there are others.

[UnlearningEcon]

"UE it just depends on your production function. If you use Cobb Douglas and K=0 then output is zero and marginal product of labour is defined, at zero...Not for first time, I can't resist: you should have learnt some more economics before you started unlearning it."

Sigh.

You can differentiate a Cobb-Douglas production function with K set to zero if you want, and get zero. That doesn't show anything, except you have mastered very basic mathematics.

Alternatively, you could pay attention to what I'm actually saying, which is that labour and capital must be employed simultaneously; in the real world, unlike in C-D world, you cannot add more and more of one to squeeze more and more out of the other. Hence, there is no coherent 'MPL' because the function is discontinuous or 'lumpy' and therefore NOT differentiable.

"If you have a production function in which output may be produced with labour alone, then MPL is whatever it is."

This is literally impossible. I challenged you to produce anything without using some form of 'capital' (which, being the catch all it is, uses land, which you have to exist on).

[nemi]

Luis:
"I'm never quite sure what counts as neoclassical and what doesn't. If it means perfect competion, factors paid marginal products, clearing markets, then nobody thinks that describes labour markets, although many people think useful work can be done maintaining those assumtions, like for instance "

I strongly disagree.

If your claim is that most economists would agree that the search model is better when you ask them outright, and divert their attention towards the specific issue, then yes – almost everyone would agree.

But 99 % of the time, 99 % of economists do not use that model as the base of their reasoning. Even if you discussed that specific issue 3 minutes ago, they will slip back into the position you say no one holds. Maybe there are occasions where it is a harmless simplification, but I assure you that most economist won’t know when, where and why (you might conduct a experiment yourself if you don’t believe me) – still, they use the marginalist distribution theory all the time (in blogs, research papers and policy proposals).

"For example, if you want to understand bargaining power then you need to think about outside options, and you probably need to invoke some concept not a million miles from marginal productivity to explain that in many cases."

Currently, many companies can hire people whose alternative is unemployment. If their MRP = unemployment benefits, that is purely by coincident.

[Luis Enrique]

Oh dear, that's what I get for commenting whilst drunk. My turn to apologise. I thought you meant that marginal productivity needed to account for fact that MP of taxi driver with no taxi is zero, which it can.

Look, production functions can be arbitrarily complicated and need not be differentiable, that's just convenient. You can write down Leontief or O-ring production functions. You can find examples where the marginal product is not a useful concept, in which case you'd need to add something else to your theory of explaining factor shares. and you can ask how prevelant such cases are in reality. We are bumping up, again, against the gaps between a useful abstraction and the reality being abstracted from.

These things I think are true:
1. Most economists think you can go a long way explaining income distributions by thinking about the distribution of skills, or what the worker contributes to output, and how that output is valued. And you can use simple models to get at the bones of how that works.
2. The vast majority of economists are well aware the labour market is a long way from the simple competitive story, in fact it's a canonical example of such. However some economists no doubt have an overly simplistic picture of the labour market and may downplay the importance of surplus approporiation etc.

[Luis Enrique]

Nemi, yes, often the outside option is unemployment, which ain't nothing to do with marginal product.

[FromArseToElbow]

Rebekah Brooks got £10.9m, George Entwhistle got £0.45m. The latter provoked outrage among newspaper commentators. (And no, Entwhistle's payoff should not be seen in the context of his short tenure as DG, but as reward for a 23-year career with the Beeb).

Even allowing for a discount on public service roles, a factor of 24 does point to a significant disparity in power.

[Peter Whipp]

When man developed agriculture some 6,000 years ago, he could produce more than was absolutely necessary to keep him alive. That allowed the ruling classes who controlled the means of production (land at that stage) to exploit the masses through enslavement in exchange for the most minimal subsistence. Money offered potential salvation because workers could be paid enough to buy all of their production but unfortunately the quantity of money that actually circulates to workers and back to producers has only very rarely kept pace with workers' production. Karl Marx recognised this trap caused by the Surplus Labour which results from increasing productivity. The trap is particularly apparent at this time. Governments should take the right to create money away from banks and then create enough new money to assure that all those who are willing and able may work for sufficient wages to buy all of their production. Labour should be a scarce resource. A government for the people could make it so.

Please read my book, "The Trouble with Money".

[Prabhat Pingreja]

now that we clearly understand that free markets dont work. i.e, we know that there are abnormal returns to capital. what is the solution? see, government intervention doesnt work. its a structural problem. Government would just clip the problem and the problem would persist.

[binary options]

There isn't much we can do about it, money goes to money ! Politics are too much involved with capitals to care for free Markets, unfortunately !