Piketty’s Model of Inequality and Growth in Historical Context, Pt 1

The first economic model: François Quesnay’s Tableau Économique

In Thomas Piketty’s doomsday model, slowing of growth in the twenty-first century will cause an inexorable increase in inequality. Piketty is not the first to propose a grand model of inequality and growth. To get some perspective on his model, let’s see what the “classical” economists had to say (Part I), and how the “neoclassical” economists responded (Part II).

Part 1. The Classical Economists on Inequality and Growth

The first generation of “classical” economists, notably Francois Quesnay (1694-1774) in France and Adam Smith (1723-1790) in England, knew perfectly well where inequality came from. It was simply a fact of life that most land and other natural resources belonged to a small hereditary nobility. In England, some 2% of the population owned most of the land. This nobility, or their ancestors, gained their estates by force, favoritism, or fraud: that is, conquest, gifts from the king, or bribes to magistrates.

The classical economists recognized that landowners, large and small, received unearned income for the mere fact of holding titles protected by the state. They called this unearned income “rent”. Besides the landowners, these economists identified two other social classes: capitalists who received profit by investing or interest by lending, and workers who received wages. (Of course they recognized that the classes overlapped; successful capitalists soon bought land or married their daughters to landowners.)

Smith, witness to the English industrial revolution, proposed the first coherent theory of economic growth. At the start of his Wealth of Nations (1776), he explains how production increases dramatically when workers cooperate and specialize. This can happen both within an enterprise—he gives an example of a “pin factory”—and through market exchange. Hence both increase in population density and improved trade—greater “extent of the market” as Smith puts it—will generate economic growth. That’s why Smith, like Quesnay, advocated free trade, both domestic and international. They opposed government-granted monopolies, such as exclusive trading privileges given to the British East India Company. They also advocated shifting taxes off of activities such as transport and sale of merchandise and onto rent, by taxing land values—what Smith termed the “most equitable” of taxes.

Smith observed that growth was already improving workers’ living standards, as well as undermining the elite landholders. So in his view, growth reduced inequality.

The next generation of classical economists brought new and more dramatic perspectives to growth and inequality.

Thomas Malthus (1776-1834) claimed that workers’ wages would forever remain at “subsistence” due to their alleged propensity to breed faster than food production could increase. Any efforts to feed or otherwise assist the poor were actually counter-productive; the poor would just breed faster. By this logic, growth increased inequality, because the bottom remained stuck. This view, while pleasing to the elite, would have horrified the humane Adam Smith.

David Ricardo (1772-1823), Malthus’s contemporary and friend, proposed a “marginal” theory to explain the magnitude of land rent. The rent of a given parcel of land depends, he said, on its superiority to land barely worth using, that is, “marginal” land. Imagine you are a farm operator. How much more would you be willing to pay the owner of a fine flat parcel down in the valley over a remote, steep parcel you could use for next to nothing? That extra payment is your rent—income to the landowner for the mere fact of holding legal title to land. (Note that location is usually the most important component of land quality.)

Ricardo’s rent theory led him to propose a doomsday model even more frightening than Piketty’s. As population grows, he said, the economy must expand onto lower and lower quality land. Since rent depends on the difference between the best and the poorest land in use, more and more of the economy’s production will go to landowners as rent. Eventually the landowners will take so much that there won’t be enough to provide even starvation wages to workers or minimal profits to capitalists. Only improved technology and gains from trade can stave off collapse. Hence, Ricardo vigorously advocated free trade.

In the final generation of classical economists, two—Karl Marx (1818-1883) and Henry George (1839-1893)—attacked inequality with such force as to provoke a powerful backlash.

Karl Marx, a German revolutionary exiled to England, rejected Malthus’s wage theory. He focused on exploitation of workers by capitalists, among whom he now included landlords. However, like Ricardo, he predicted that growing inequality would lead eventually to a collapse of the capitalist system, and its replacement by a new socialist society. In effect, Marx said growth increases inequality, leading to revolution followed by equality.

Henry George’s bestseller Progress and Poverty (1879) threw a searchlight on the inequities of the late nineteenth century. With Marx, George rejected Malthus’s wage theory. He added his own twist to Ricardo’s theory of land rent. Just as marginal land determines rent, he said, it also determines wages—because a worker will not accept wages lower than what he could earn for himself on marginal land. But the greater the inequality of ownership of land (and other natural resources) the lower will be the quality of marginal land—and hence the lower the wages.

George also added a twist to Adam Smith’s theory of growth. Yes, growth results from cooperation and specialization, and the larger the population and the greater the “extent of the market” the greater the potential for growth. But also, the more equal the people, the greater their ability to cooperate. In George’s words: “association in equality is the law of progress.”

Marx saw history as progressing by action and reaction toward the inevitable overthrow of capitalism. By contrast, George combined his modified growth theory with Ricardo’s inequality theory to argue that progress carries the seeds of its own destruction: A fortunately-situated, relatively egalitarian society may begin to grow and prosper, expanding and attracting population. However this growth primarily benefits the holders of key parcels of land—such as parcels on the waterfront of port cities. As the economy grows, so does inequality. Wages fall, relatively if not absolutely. A wealthy, corrupt elite increasingly controls government. Eventually, the society collapses, or becomes so weak as to fall to invaders—as for example did the Western Roman Empire.

George feared this fate would soon befall the United States. Like his classical predecessors, he opposed government-granted monopolies, notably vast tracts of land handed to railroad companies like Southern Pacific. Also like his predecessors, he proposed shifting taxes onto the unearned income of land and other natural resources. But unlike his predecessors, George turned land taxation into a major and partially successful political crusade, not only in the United States, but in other countries, notably England and its colonies in Canada, Australia, New Zealand, South Africa and Hong Kong. In practice this meant increasing the land component of ordinary property taxes and removing the component on buildings and other improvements, a proposal easy to understand and implement back when property taxes were the primary taxes.

Marx and George—and the huge political movements they inspired—scared the pants off the elites of Europe and the United States. They had to be stopped, and not just physically. The classical focus on inequality and unearned income had to be disappeared from economics. As we will see in part II, that was the purpose of “neoclassical” economics.

–Polly Cleveland

Report on Working Families Summit, Plus One More Link


(1) Tim Koechlin, “Inequality and the Case for Unions.”  In my Monday Links post, I meant to include this excellent piece by sometime D&S author Tim Koechlin, which appeared at Common Dreams and at Huffington Post. It’s a careful account of how workers as a whole benefit from strong unions. But I especially like the parts where Tim takes Democrats to task for not defending unions and workers’ rights.  “De-unionization is not an imperative of the global market.   It is a political choice.”  

(2) Report-Back from the White House Summit on Working Families by Deb Figart.  Deb Figart, who will have a piece in our July/August issue on so-called “alternative banking

Back to the Grassroots for Work-Family Balance

By Deborah M. Figart

The United States is the only developed country in the world without paid family leave. Access to paid leave is a key issue for working families. So are raising the minimum wage, universal pre-school, affordable child care, guaranteed paid sick leave, and paycheck fairness.

On Monday, June 23, 2014, President Obama brought together policymakers, business and labor leaders, academic experts, and activists for the White House Summit on Working Families. Besides President Obama, other speakers on the program included, for example, Vice President Biden and Dr. Jill Biden, First Lady Michelle Obama, House Leader Nancy Pelosi, Maria Shriver (of the Shriver Report), Ellen Bravo (President and Founder of Family Values @ Work) and Gloria Steinem. Frustrated with the gridlock in Washington, the President is serving partly as “Organizer-in-Chief,” hoping to rally us to affect change at the local and state levels. The President argued that 21st-century families are struggling to survive with polices from the Mad Men era. (Actress Christina Hendricks, who plays Joan Harris on Mad Men, was in attendance).

Obama is also using executive powers to issue Executive Orders and memoranda where he can to affect the well-being of federal employees and workers employed by federal contractors. In April, on so-called Pay Inequity Day, President Obama issued an Executive Order that protects federal employees from retaliation if they disclose their salary. Salary transparency at the workplace helps reduce the gender- and race-based wage gaps. This is part of the Paycheck Fairness bill that has been stalled in several sessions of Congress. As outlined in his State of the Union address last January, the President, also by Executive Order, raised the wage for employees of federal contractors to $10.10 per hour.

Two companion policy announcements were made at the event. President Obama proclaimed that he had asked Secretary of Labor Thomas E. Perez to make available technical training grants to low-income individuals training for in-demand industries. That’s because low-income persons struggle to cover child care costs while attending federally-funded job training or retraining programs. Working parents, he argued, should not have to choose between taking care of their children and trying to train for a new career.

Second, President Obama intended to sign a presidential memorandum to require all federal agencies to expand access to flexible work schedules. That he is using the federal government as a model employer, hoping for a demonstration effect, is not insignificant. Katherine Archuleta, Director of the Office of Personnel Management, shared that the federal government is the nation’s largest employer with 2 million workers on the payroll. Only 15 percent of them work in the nation’s capital. The federal government already has a flexible workweek, so we will have to wait and see the details.

So there was much talk from business leaders and policymakers alike about the need for workplace flexibility. I listened to numerous first-hand accounts of beneficent employers who allowed their professionals to tele-commute from home. Or to leave early for a high school graduation, a Halloween parade, or a soccer game. But flexibility for whom? There was little discussion about how to extend flexibility to frontline service workers, most of whom are paid by the hour. What about employees who must remain on the line—in the factory, in food service, or in hotels and casinos, for example? And flexibility can have a high road or a low road. With the rise of the “precariat” (see Guy Standing’s book), will more part-time, contract, and contingent workers report to the work site only when called in from being on call? Or will employers increase full-time, year-round work and trust their employees to do the job?

Much of the focus was on asking us to advertise the return on investment of family-friendly policies. This message was delivered by Betsey Stevenson, member of the President’s Council of Economic Advisors. Such policies improve recruitment and retention as well as boost productivity and profits. The empirical evidence has been published as a series of new fact sheets by the Council of Economic Advisors, with titles such as “Work-Life Balance and the Economics of Workplace Flexibility,” “The Economics of Paid and Unpaid Leave,” and “Nine Facts About American Families and Work.”

Americans overwhelmingly support these policies. We just need to convert this to tangible progress. Valerie Jarrett, Assistant to the President and Senior Advisor, closed the White House Summit as she began it, with a message about going forward to make change: “This Summit is not just a moment, it’s a movement.” Other quotes from the Summit are available from the Center for American Progress, a chief sponsor along with the White House and the U.S. Department of Labor.

Deborah M. Figart is a Professor of Education and Economics, The Richard Stockton College of New Jersey.