Piketty’s Model of Inequality and Growth in Historical Context, Pt 2

by Polly Cleveland | July 23, 2014


Part II: The Neoclassical Response to the Classical Theories of Inequality and Growth

Mason Gaffney has shown how many individuals helped construct neoclassical economics, often with financial support from the robber barons and their successors. I will focus on two: in the United States, John Bates Clark (1847-1938), and in Europe, Vilfredo Pareto (1848 to 1923).

Recall from Part I that the classical economists divided society into three classes: Owners of land and other natural resources received unearned income or “rent” from their holdings—often derived from conquest or inheritance. Capitalists (who often overlapped with landowners) owned physical capital (like factories or ships) and received interest or profit from investing. Workers received wages. Also recall that the classical economists favored taxing “rent” by taxing land values; Henry George crusaded for this tax.

John Bates Clark of Columbia University, for whom is named the prestigious John Bates Clark Medal, transformed economics into an inequality-free abstraction.

Writing in the 1890’s, Clark merged land into physical capital, thus obliterating the classical understanding of land. In the new neoclassical world, capital (including land) originates solely from productive investment. There is no unearned “rent”, only legitimate “profit.” (Ironically, Marx merged rent into profit because he considered both illegitimate.)

Clark reduced economics to only two “factors of production”, capital and labor. In Clark’s model, “supply and demand” in a free market ensure that capital and labor each earns its “marginal product”, that is, the contribution of the final amount supplied. This outcome is supposedly both fair and efficient. Clark writes, “the share of wealth that falls to any producing agent tends, under natural law, to equal the amount that he creates. A man’s pay tends to equal the value of the product or fraction of a product that can be specifically imputed to him.” (Clark, 1898: 4)  So much for any claim that laborers are exploited!

Clark also eliminated time, —giving us the familiar time-less, space-less, context-less world of Economics 1. But without time, there can be no history, and without history, no questioning the justice of property ownership, or the legitimacy of institutions.

Neoclassical economics in the United States followed Clark, to the extent that the future Clark Medal and Swedish Bank “Nobel” prize winner Robert Solow could joke in 1955 that “…if God had meant there to be more than two factors of production, He would have made it easier for us to draw three dimensional diagrams.” (Solow, 1955: 101)

Meanwhile, over in Europe, Italian nobleman Vilfredo Pareto made two key contributions to the emerging neoclassical paradigm. First, he estimated that 80% of the land in Italy belonged to 20% of the population, from which he concluded that inequality follows a natural law: the 80:20 rule, with which we shouldn’t tamper. More famously, he developed the policy rule known as “Pareto improvement.” Pareto improvement holds that we should undertake no policy changes unless they make at least one person better off and no one worse off. Sounds fair and reasonable, doesn’t it? By that logic we should have paid the slaveholders in full after the Civil War! By that logic once having cut taxes on the rich, we cannot raise them again! The status quo rules, no matter how cruel or illogical the route that got us there.

Under the new neoclassical regime, mathematical models proliferated like kudzu vines in the south, their very complexity keeping them safely obscure. Few are more famous (among economists) than Robert Solow’s 1956 simple two-factor growth model. Assuming a world of uniform depreciating physical capital (implicitly ignoring durable natural resources like land), and uniform quality labor, Solow’s model predicts that economies will grow towards a steady state where depreciation just equals new investment. And because the richer you are the slower you grow, poorer economies and poorer people within economies will catch up. Solow’s model is cute as a button!—but its extreme abstractness lies poles apart from Smith’s original common sense model explaining growth in terms of cooperation and specialization.

Almost sixty years later, Thomas Piketty has taken Solow’s model and added his own twist. In Solow’s model, the poor catch up to the rich. In Piketty’s model, the modern decline in growth does not affect investment. Consequently, now that return to capital investment exceeds the rate of growth, then inequality must inexorably increase. This model, he says, determines the fate of the twenty-first century.

Critics have torn into Piketty’s model—including some, like James Galbraith, who still give Piketty kudos for stirring up debate. In my view, Piketty’s and Solow’s models are both fundamentally flawed in that they rest on the same ahistorical, apolitical, two-factor neoclassical foundation. As the classical economists understood, inequality derives from power, ultimately the power of conquerors to extract tribute from the conquered. And as the Progressives, the New Dealers, and the civil rights activists have demonstrated, democratic societies can counter that power with well-designed tax and regulatory policies supported by an aroused public. We are not prisoners of a mathematical model.

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The Supreme Court’s Supremely Inconsistent Same-Day Decisions

by Ron Baiman | July 17, 2014

Mad Tea Party Illustration

Originally posted at the website of the Chicago Political Economy Group (CPEG).

Let me get this right.

An association of people with an elected leadership with no direct authority over its members whose primary purpose (which its members get to vote on) is to benefit its members, is so potentially oppressive to its members that they have the right to not pay the association for any its benefits (like more than doubling their wages in the last 12 years even as the association is required by law to provide these benefits to them.

However, an association of people with unelected ownership-based leadership (some would say “class power”) that has direct authority over its members (in the sense that it can tell them – with some broad legal limits – what to do for 40 hours week, see for example: Economic Democracy by Robin Archer) whose primary purpose (in the U.S.) is to benefit its owner/leaders so that it is directly commanding its members to do things not in their interest but in the interest of the owner/leaders, has no oppressive power over its members but quite the opposite. The leader/owners of this association will be “oppressed” if they have to not discriminate in benefits that they are legally required to offer to their members.

Let me restate this is simpler terms.

In democratic organizations whose purpose is to benefit members, we’re worried that requiring members to pay for benefits that they have voted on and received, will violate their civil “right” to free-ride by not paying for received benefits?

But in authoritarian organizations whose overriding purpose is to benefit owners, we’re worried that requiring the owners to pay for legally required equal health benefits for women and men will violate their civil “right” to discriminate against women based on their religious precepts by denying them certain kinds of health benefits?

One more time.

In democratic organizations we’re worried about “top-down” oppression of members by not allowing them to “free-ride”?

But in authoritarian organizations we’re worried about “bottom-up” oppression of bosses by not allowing them to discriminate?

Yup. You got it. The first is the Supreme Court’s Harris v. Quinn decision, and the second the Hobby Lobby decision, both released on Monday, June 30, 2014.

You couldn’t ask for a better demonstration of the bankrupt “classic liberal” and Neoclassical Economic ideology of corporations as “private” actors with no social power, a “free and voluntary” realm of “equal exchange” contracts, vs. its view of unions as oppressive sources of tyrannical power that impinge on “individual civil rights”. What could be more backward!

And note that the standard argument that the power of “exit” makes the labor contract “voluntary oppression” (which is nonsense anyway as we all know most workers cannot just “quit” their jobs without potentially incurring severe costs to themselves and their families especially in the current economy with close to 10 million “officially unemployed!) doesn’t work here in any case.

Why is it somehow less oppressive for a women at Hobby Lobby to have to quit her job in order to find an employer who won’t discriminate against her, than it would be for an SEIU HCII member to quit his/her job to find one without an “oppressive” union forcing her/him to pay a “fair share” fee for raising his/her pay and benefits?

Oh but I forgot.

The second association is a “person” whose “civil rights”, including its “right” to impose its religious precepts on its members without their consent, cannot be violated. For example, even though it is an expressly undemocratic organization whose purpose is to serve its owners/leaders and not its members, it has a “free speech” “right” to use money derived from its members for political or other purposes over which they have no say.

But the first, democratic, association that works for its members does not even have the right to be compensated by its members for work that it does directly for them. This association is a potentially oppressive tyrant that is already is prohibited from using money derived from members for political activity without their consent.

Talk about “Alice in Wonderland” Logic – these guys (the five) belong in a rabbit hole not on the Supreme Court!

–Ron Baiman

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