Of labour income and shifts in income inequality

This is based on a comment I made here.


There are a host of issues with inequality: of the significance of income versus consumption inequality, for example. But that income inequality in the US has been increasing in recent times, (on some indicators) back towards the levels of the “Gilded Age”, is fairly clear. The effect is particularly concentrated at the very top of incomes.

Paul Krugman divides the history of C20th income inequality in the US into the “long Gilded Age” until about 1938, “middle class America” of the Great Compression from then until the mid 1980s and the “Great Divergence” since. A pattern he has tied it to political polarisation and financial deregulation.

Krugman is arguing that it is basically a creation of public policy. That the New Deal deliberately compressed incomes until the “supply side” policies of the 1980s reversed the effects. I suspect that public policy has less effect than Krugman claims.

It is worth noting, for example, that the US federal income tax is wildly progressive. The top 5% of income taxpayers pay over half of total federal income tax receipts. The top 20% of income taxpayers pay over 80% of total federal income tax receipts. Even given that the income figures cited above are about market (i.e. pre-tax) incomes, the income transfers of the US government work in the reverse direction to that which Krugman is indicating. So, for the “public policy did it” explanation to work, it must be overwhelmed by other aspects of public policy. For example, Krugman might have a point about the finance industry.

Still, there could be other factors are at work driving up capital and driving down labour incomes (relative to each other).

It is easy to nominate social changes that could be increasing income inequality.

(1) Immigration: widening skill differentials and driving down labour income (and therefore putting upward pressure on capital income).
(2) Increased life cycle inequality with the expansion in higher education, as poor students become highly paid professionals later in life, and increasing skill differentiation.
(3) Women entering the workforce, putting downward pressure on labour income (and thus upward pressure on capital income) and increasing household differentiation as high-income women marry high-income men.

In the C19th, there were temperate and tropical zone labour flows. A vital interest of labour politics in North America and the Antipodes was to block tropical zone labour flows competing with them. (Hence the White Australia policy and anti-Chinese immigration sentiment in both regions.) But even within the temperate zone labour flows, a lot was fairly low skill. The effect of the mass immigration to the US was to increase skill differentials and put downward pressure on labour income (and upward pressure on capital income): hence the inequality of the "Gilded Age".

There was a dramatic drop off in migration in the interwar period. After some lag, there was consequently downward pressure on capital income and upward pressure on labour income. In the postwar period, there was high productivity growth and immigration was largely from Europe, and the more educated and industrialised parts thereof. Capital growth more than compensated for labour force growth, so there was upward pressure on labour incomes and downward pressure on capital incomes (relative to each other) with little or no widening of skill differentials. Hence the "great equalising".

Then productivity growth died away, migration became much more "tropical zone", women flooded into the workforce. There was downward pressure on labour income, widening skill differentials and upward pressure on capital income (due to increased relative scarcity). Combine that with increased life cycle inequality (due to mass higher education) and high-income women marrying high-income men and you get flat labour income and increased income inequality. (And yes, I am aware of the claims that the net effect of migration is to increase per capita incomes. Maybe, but it does not increase specifically labour income, which is my point.)

So how much public policy changes drove, or responded, to these underlying patterns, a fascinating question. But I am sceptical how much public policy can counteract these effects.

I also disagree with Krugman’s take on the wider the effect of Reagan. There is little point in comparing Reagan’s performance with the period of high productivity growth. The interesting comparison is with other developed democracies at the same time as his term in office. The "supply side" reforms that started under Carter led to the US pulling away from European countries in per capita income, after the post war decades of convergence in per capita income as European countries got over the effects of Dictator’s War and technology spread in “technological catch up”. Reagan did well under the comparison that counts—similar countries in the same general context.

A lot of factors affect both relative economic performance and trends in income inequality: analysis needs to carefully consider the complete context, rather than focusing on what seems congenial to blame or credit.

The protection of the public eye

Blogging in Cuba is not the safest of occupations. Here is a request, received by email, by and on behalf of such bloggers:

Many people want to do something to help the bloggers directly. The most important thing is to read them, talk about them, comment on their blogs, share their blogs with others, keep them IN THE PUBLIC EYE, which is a shield that helps to protect them.

So, here are some blogs to follow:

Generation Y

Sin Evasion/Without Evasion

Laritsa's Laws

Octavo Cerco

Dimas's Blog

The Birth of the Nazis: the Freikorps

Nigel Jones' splendid A Brief History of the Birth of the Nazis: How the Freikorps Blazed a Trail for Hitler is an excellent rendering of the turbulent period in German history from the abdication of the Kaiser on 9 November 1918 to failure of the Beer Hall Putsch of 8/9 November 1923. So a period of precisely five years, but a very exciting five years.

The collapse of the Kaiserreich in defeat and hunger left a gap in legitimacy and authority that the proclamation of a German Republic did not solve. No part of the borders of the Reich had been breached when Germany sued for peace, so it was easy to deny that Germany had "really" been defeated--leading to the "stab in the back" myth, a phrase first coined by a puzzled British general in conversation with Ludendorff (p.171). Ludendorff comes across as a wholly odious character--physically brave but an appalling moral coward who avoided any responsibility for the military outcomes he was more responsible for than any other German officer. He was an entirely pernicious influence in the new post-Imperial Germany.

Large parts of the judiciary, civil service, Reichswehr, academe, police and other "pillars" of order where hostile, or otherwise unreconciled, to the new Republic. Something that showed up dramatically in the derisory sentences (or even acquittals) handed out to right wing political killers and violent plotters and contrasted with the severity that left-wing equivalents were treated to.

With well-entrenched enemies on the right, the shaky German Republic had also to contend with territorial ambitions of new neighbours in Poland and the Baltic States, revolutionary outbreaks inspired by the success of Lenin's Bolsheviks in Russia and vengeful Western Allies who imposed a dictated peace treaty on the new Republic.

Though the Treaty of Versailles was not as vicious as the Treaty of Brest-Litovsk that the Ludendorff and the Second Reich had imposed on its defeated Russian and Romanian enemies. Indeed, both Treaties were failures. Brest-Litovsk meant that significant German forces (particularly its cavalry) were busy trying to secure what turned out to be empty gains in the East and so were not available to exploit Germany's initial gains in the Ludendorff offensive, an offensive launched without any arm of exploitation. (As one historian has noted, Ludendorff the politician defeated Ludendorff the general.) While the Versailles Treaty, as an imposed diktat, was one no Germans felt in anyway committed to; except as an unfortunate burden to be shed as soon as practicable. The aristocrats and gentry of the Congress of Vienna a century earlier did much better than the democrats at Versailles. (But then, as a hereditary elite, they and their children had to live with, and manage, the consequences.)

In order to defend against revolutionary outbreaks and aspirations at home and territorial intrusions on the borders, the new Republican government turned to the Freikorps, paramilitary formations formed of refugees from the demobilised Reichswehr officers and troops and right-wing students. Violent and contemptuous of the new Republic and its politicians, the Freikorps were dangerous and unreliable instruments. Gustav Noske, the new SDP Defense Minister, was ruthlessly determined to put down any signs of revolution so that the new Ebert Government did not suffer the fate of Kerensky's in Russia.

In this he succeeded, at considerable cost in blood and by feeding the ambitions of the Freikorps, which culminated in the Kapp Putsch. This was defeated by the passive resistance of most of the civil service and a general strike. The latter manifestation of successful worker power then led to another round of revolutionary alarms, forcing the Republic to once again call upon the Freikorps.

Eventually, the Republic stabilised, particularly with the widespread revulsion against the murder of the Republic's Foreign Minister, the urbane and cultured wealthy cosmopolitian Walther Rathenau. But large parts of the working class were alienated from the Republic, giving the KPD a solid voting base and creating a Reichstag bloc in permanent opposition which, as it grew, made forming a majority government increasingly difficult.

The Freikorps also faded away, but left a legacy of violent paramlitarism that was to feed into the new Nazi Party. Its Beer Hall Putsch was both the final surge in Freikorps activity and expressed much of the trends of the period (including Ludendorff's consistently awful political judgement: the Putschists having successfully captured the key figures in the Bavarian Government, Ludendorff released them on their word--as soon as they were free, they promptly organised the violent suppression of the Putsch). The Putsch itself was a deliberate emulation of Mussolini's March on Rome, but aimed at a regional capital (Munich) and was too little too late, since the greatest fears of revolutionary collapse had subsided, as all such attempts have been successfully (and brutally) repressed.

Its failure both gave the new Nazi Party a myth of martyrs and blood sacrifice while convincing Hitler that power was going to have to come via the ballot box. After his release from fortress confinement, he concentrated on organising an effective movement which was already consolidating its dominance of the violent right of German politics when the 1930s Depression gave them the crisis opportunity they needed.

Nigel Jones' prose is clear and vivid. This is history which is both exciting and perceptive. It is an excellent rendition of the violent, and deeply flawed, birth of the Weimar Republic, and the prehistory of the Nazis.

Property rights for animals

This is based on some comments I made here on a proposal to give animals property rights in order to protect habitats.


Presuming that the point of the exercise is not simply a green power grab (which is what it looks like) but to change people’s behaviour, then adding to people’s future possibilities rather than threatening their present ones seems a better way to go.

In his Economic Analysis of Property Rights Yoram Barzel notes differences between UK and US habitat law, which I summarized as:

Another striking Barzel example is property rights in wildlife (Pp145-7). In the UK, farms tend to be larger than habitats, so property rights to wildlife are largely held privately as habitats are largely encompassed within private holdings. In Canada and the US, farms tend to be smaller than habitats, so the state assumes much more control over wildlife, as habitats generally extend across several, or even many, holdings.

A famous example of giving people a stake in preserving wildlife is giving local people ownership rights over their local elephants rather than just banning poaching. The former means that live elephants are a continuing source of income, the latter means the only profitable elephant is a dead elephant.

If live possums or whatever a boon for the farmer, then there will be more live whatevers. There is no such thing as an endangered profits-from-owning species.

Property rights evolved as a way of creating productive boundaries. Harold Demsetz, in his classic 1967 article Towards a Theory of Property Rights uses the example of beavers in North America. As the fur trade developed, Amerindians developed property rights in beaver dams. An example of productive interactions, considered by Steven Cheung, is bee-keepers and apple farmers. (Coase’s classic The Problem of Social Cost (pdf) considers these sorts of interactions.)

The proposal to give animals property rights, does not create productive boundaries, it creates anti-productive boundaries; it does not increase human possiblities, it lessens them. Not a clever idea.

Property-rights environmentalism has a lot to be said for it, but precisely because it increases human possibilities, not because it undermines them.

As for the comment in the above-linked thread from an advocate of the proposal

Why do so many land holders react with hostility to the idea of having to talk to others about their land use decisions? I might be an optimist but considering all the other supposed regulatory burdens upon land holders, is what I’m suggesting all that more demanding?

Because there are only so many ours in the day? Because it is their livelihood one is talking about? Because their experience of other examples is not a happy one?

Discretionary controls by officials inevitably become dominated by the politically well-connected. The notion that this would be a reliably benign process is belied by an enormous amount of experience.

As for “talking to others”, once one shares control of some attribute, one raises transaction costs, lowering the number and return on such transactions. To quote Michael Kirby, then High Court Justice, certainty is the central demand of land law. Clear boundaries allow productive trades. Unclear boundaries undermine such: sometimes profoundly. If a way exists to eliminate the problem (such as eliminating the problematic animals), it is likely to be taken.

Here is a question: would landholders be compensated for their loss of rights, or a we talking about simple theft here? A property right is a right of control up to a boundary. If you create “property rights” for animals, then any previously existing right of control in that boundary is eliminated. Someone else — the landowner in this case — loses rights. So, will there be payment for such loss or is it going to be simple theft?

As for appealing for “good intentions” by landlords, incentives matter. They matter a great deal. Given the potential power over land use this proposal gives, one must expect that people will politically organise to gain control over that power.

This is one of those basic analytical differences. Libertarians and others presume that private interests are endogenous to the political process and will game it according to the incentives generated. Progressives of various stripes presume that political processes can somehow be made exogenous to private interests and “control them” from outside. This is nonsense on stilts, and pernicious nonsense at that.

The more proponents argue for this proposal, the more alarming I find it. The issue is not the intention, but the means suggested.

Markets with clear rules have shown excellent ability to trade attributes to their most efficient holders. For example, we pay to have the attribute ‘liable to catch fire’ allocated to insurance companies according to rules which work fairly well. The trick is being able to define boundaries to the attributes and to trade them to mutual benefit.

If one does not have such defined boundaries, one just has a mess. And the experience of officials (actual or quasi) having joint control over attributes with private property owners is not a happy one. (Such as aiding and abetting NIMBY and BANANA — build absolutely nothing anywhere near anyone.)

It is not a lack of imagination that leads to the scepticism about this proposal, it is the application of experience against comforting theories about good intentions.

Money and expectations

I recently listened to talk by a former Chief Economist for the Reserve Bank of Australia. He was speaking to a lay audience and gave a nice rendition of the basic intuition of monetarism, presenting its central idea as being based on the Fisher equation of MV = PT and, assuming V (number of transactions money goes through in a given time period: often converted into k = 1/V or the proportion of money held as cash) and T (total number of transactions: often simplified to total production of goods and services in a given time period, ‘y’) do not change much, then a rise in M (money supply) will lead to a rise in P (price level).

Basically, in monetarism, it is all about the quantities. Hence monetarism relies on the notion of ‘long and variable lags’ to make this quantity story work: in other words, it invokes a ‘fudge factor’.

Monetarism does accept that a short run effect of rising money supply can be a rise in production (as discussed below) but, in the long run, the rate of inflation is determined by the rate of money expansion in excess of the rise in production, but with "long and variable lags".

The historical evidence on the fundamental claims of monetarism is not as cooperative as it might be. As one economic historian notes:

From my own studies of monetary and price history over the past four decades, I offer these observations, in terms of the modernized version of Fisher's Equation of Exchange, for the history of European prices from ca. 1100 to 1914. An increase in M virtually always resulted in some degree of inflation, but one that was usually offset by some reduction in V (increase in "k") and by some increase in y, especially if and when lower interest rates promoted increased investment. Thus the inflationary consequences of increasing the money supply are historically indeterminate, though usually the price rise was, for these reasons, less than proportional to the increase in the monetary stock, except when excessively severe debasements created a veritable "flight from coinage," when coined money was exchanged for durable goods (i.e., another instance in which an increase in M was accompanied by an increase in V).

The quantity story is not enough for several reasons, starting with the flexibility of supply mattering (as monetarism itself acknowledges). For example, in the C16th and C17th, Asian goods coming into Europe was an upward supply response that would have dampened the inflationary effect of the Central European and American silver flows and the various debasements of coinage (notably the English debasements of 1526, 1542 and 1553 – the total reduction in silver content of coins reaching 83%, though Elizabeth’s recoinage of 1560 reduced the loss to 25%, a further debasement in 1601 bringing the total loss of silver content to 36% – while the silver coinage of the Southern Low Countries was debased 12 times from 1521 to 1644, totalling a 49% reduction in the silver content of coins).

But if the responsiveness of aggregate supply matters, that gets in the way of telling a quantity story. Hence the “long and variable lags”.

The quantity story is, however, also not enough because one has to look at people’s expectations, for that will affect their holding of money (i.e. k) and so how much money is in circulation (i.e. the level of spending: Py). The upward responsiveness of aggregate supply of goods and services to any increase in spending determining how much the response is in prices (P) and the downward responsiveness of prices determining how much any fall in spending is reflected in falling production (y). (Or, to put it another way, whichever of prices or production is more constrained will lead the effect of any change in spending to be greater in the other.)

Institutions also matter: what forms of money there are, how available credit is. So, changes in institutional structures will change the significance of various monetary aggregates. One of the notorious problems of monetarism is trying to work out which monetary aggregates to follow and when. Money is a tool of human action, so what happens to it and what it does is about human behaviour which change as institutional structures change and vice versa: a quantity story is never going to be enough.

Money complexities
It is easy to go wrong in thinking about money as it is so central to so much economic behaviour. One of the basic things money does is that it simplifies. Without money, people are stuck with barter price(s) – price in terms of goods and services. Money prices are much simpler to deal with: everything for sale then has a money price in terms of a unit of account, a single number. (Money has barter price(s) – what it buys in terms of goods and services: what economists call ‘real price’ is some average barter price across a “basket” of goods and services at some point or period in time expressed in numerical – i.e. “money” terms – to make it manageable.)

Money – as the medium of account: that is, a medium of exchange that embodies the unit of account – also connects across time. We accumulate existing obligations from past actions, obligations that are specified to be paid in the medium of account. We also have future spending intentions, making us attentive to money as a store of value. Our expectations about the future path of money as a store of value will affect our current holding and spending patterns; our use of money as something to hold (k) or something to spend (Py) in the current time period. So, if we expect money to seriously lose value, the incentive is to spend it; if we expect it to gain value, the incentive is to hold on to it.

These simplifying and cross-time aspects of money means that money matters in its own right, it is not simply a “transparent” connector to the “real economy” of goods and services. (So monetarism is correct in that.) Particularly as we are not immediately aware of all shifts in the barter price(s) of money: money is a response to a real information problem (keeping track of all those relative prices) yet, while it hugely reduces the information problem, it does not abolish it (since there is still the issue of becoming aware of shifts in the average barter price of money).

(I keep using the term ‘barter price(s)’ because I have come to dislike the terms ‘real price’ or ‘real wages’ as they skate over the information problem that money exists to solve and which is fundamental to how people use and think about money. So using ‘real price’ or ‘real wage’ becomes actively misleading even though talking of the 'barter price(s)' for money sounds a bit odd. Though surely no more odd than calling statistical artifacts 'real prices' and 'real wages'.)

While money does therefore matter in its own right, it is still just a means for human action. The constraints and expectations it is embedded in matter: there is no simple quantity story to tell. So, the level of money offers (i.e. money spent rather than held) matters, but whether any increase in spending will be inflationary or not (and how much) depends also on the responsiveness of aggregate supply.

Hence, as it is the nature of assets that they cannot respond as quickly to increased spending as goods and services can, it is easier to get much bigger inflationary surges in asset prices than in goods and services prices: surges which will be bigger the more constrained supply is. But the shift from using the Fisher ‘T’ to the Friedmanite ‘y’ diverts attention away from spending effects on asset prices.

The level of spending cannot, however, be inferred from M, since people’s expectations matter, as they will affect k. If people have low or negative inflationary expectations, then that is a reason to hold on to money. If they also have negative (i.e. pessimistic) uncertainty, that will be even more reason to hold on to money as a safety measure. If they wish to reduce debt (i.e. are “de-leveraging”), then that will also be a reason to hold on to money. So the combination of debt, negative uncertainty and low or negative inflationary expectations is likely to lead to a dramatic lowering in spending. Even while “base money” surges: relying on such quantity measures will not merely be uninformative, they will be actively misleading. Hence ‘quasi-monetarism’ [now Market Monetarist (pdf)]: monetarism with the addition that expectations matter.

So, the worst thing a central bank can do in a situation of high debt and negative uncertainty is to reduce liquidity (and so both the availability of money and the expected path of money supply); thereby creating expectations of low or negative inflation, leading to a “flight to cash” and a dramatic drop in spending leading to a dramatic fall in Py (i.e. nominal GDP, GDP in straight money terms), with the drop in y (economic activity/output) being bigger the more downwardly constrained prices are.

This debt-and-deflation story is basically Irving Fisher's story (pdf) about the Great Depression. It is also what happened with the recent Global Financial Crisis and Great Recession (see this chart of changes in nominal GDP and employment).

An example of downwardly constrained prices are wage contracts operating across time incorporating significantly higher inflationary expectations than actually occur, so that the price of wages in terms of goods and services – their barter prices – rise as demand for what they produce is falling. With such wages being downwardly “sticky” since cutting wages means breaking the agreed contract, creating a trust-and-future dealings problem: particularly as people have already acquired obligations to pay in terms of the medium of account, so are resistant to receiving less of such regardless of what is happening to the barter price of money.

There is a long-running critique of central banking with fiat money that fiat money central banks are inflation-addicted. But they seem to do their worst damage when they become inappropriately inflation-phobic. The question is whether these are soluble problems, or they are a manifestation in monetary policy of the classic problem of central planning – the destructive and chaotic combination of poor incentives and information problems.

Still, one can be a quasi-monetaristMarket Monetarist in macroeconomic analysis without thereby being committed to any particular position on fiat money and/or central banking. (For those interested, George Selgin has recently posted a nice defense of fractional reserve banking [via].)

So, yes inflation is “always and everywhere a monetary phenomenon” but it is not a simple matter of measuring (and manipulating) monetary quantities: one has to include constraints and expectations. Indeed, expectations are where the real game is. So targeting stable growth in Py (nominal GDP) incorporates responsiveness of aggregate supply to money offers (i.e. output to spending), works to both stabilise and respond to expectations while not being constrained by institutional changes in money. It also optimises use of a policy instrument (monetary policy) which is a lot quicker in responding than fiscal policy without the nasty debt consequences (which is to say, fiscal policy is more rigid in both operation and consequences).

So, quasi-monetarists Market Monetarists of the world unite! There is nothing to lose but misleading obsessions with monetary aggregates!

ADDENDA I have amended the post to use the term 'spending' and 'output' more and 'money offers' less and incorporate the new name of 'Market Monetarists'.