Inequality & Institutions

In session 5 we tackle the thorny issue of inequality. We already know about growth under-performance in recent decades. Moreover, if anything, Covid has made the outlook look even gloomier. Now we learn that what extra scraps there are get pocketed by the rich, leaving the vast bulk of society no better off, maybe even worse off in real terms. This is hardly a sustainable base from which to build better productivity and living standards all round. Politically, of course, non-inclusive income gains have already proved toxic.

In reviewing what is one of the top problems facing 21st century society we look at inequality from three angles (given limited time we shall focus primarily on income flows rather than wealth stocks).

  • Functional distribution: the share of GDP going to wages and profits
  • Personal distribution: the distribution of income across individuals and families within any given country
  • Global distribution: the distribution of GDP (typically on a per capita basis) across different countries at any point in time

Functional distribution

The Solow model predicts stable income shares and assumes the existence of perfect competition. However, recent data paint a very different picture. Labour’s GDP share appears to have eroded. Again, measurement problems abound, so the the numbers need careful interpretation. However, statistical doubts do not detract from the need to recognise the imperfectly competitive nature of markets – a feature which has become more prominent with the rise of so-called superstar firms. Dipping into the latest research we examine the links between imperfect competition, higher mark-ups and rising supernormal profits (rent).

Useful, easy reads on this topic are available from Bob Solow himself, writing for Pacific Standard in Aug 2015, as well as an IMF blog article from 2018. If you need it, background revision on rents, imperfect competition and market power can be found in this section of the CORE Economics textbook.

Excess corporate power is a reminder of the importance of institutional context when developing economic models. The problem is not new. We have been here before when the immense power of the East India Company eventually led to its nationalisation in the mid-19th century. Also Theodore Roosevelt’s trust-busting in the early part of the 20th century proved, for a while, a corporate gamechanger.  Will today’s giant tech companies suffer the same fate? 

Personal distribution

With the aid of Gini coefficients and quantile data we shall explore the dramatic rise of within-country equality over recent decades. General interest in the topic soared in 2014 when Thomas Piketty’s Capital in the Twenty-First Century was published in English. A 700-page economics tome topping the Amazon sales list!  Just one word – RESPECT.

Not everyone is convinced by the Piketty thesis which blends modern growth theory with history and Marxism. But the writing is beautifully crafted and the book is full of fascinating data that are supported by painstaking research. As part of his historical contextualising, Piketty makes reference to some great works of literature (it inspired me to revisit Balzac and Austen). Taking grand sweeps of gilded ages and updated Great Gatsbys we tackle his two “laws” of capitalism and place them in the context of the Solow model that you know and love.

Global distribution

Comparing GDP across countries can trip up the unwary. A key problem is exchange rates which do not always properly reflect purchasing power. So we take the opportunity to learn about international dollars and apply the concept to comparisons of the US with India and China.

We also focus on the issue of convergence. Can we reasonably expect poor countries to catch up with their rich neighbours? Or are regions like Sub-Saharan Africa doomed to poverty? The Solow model can help organise thoughts although we need to break free from its many restrictions for deeper insights.

As underlined in session 3, TFP is not simply about technology but also about institutions and politics. If you are not convinced then maybe we need to talk about Britain’s surge in GDP per capita since the mid-18th century. Was it just tech know-how (steam engines and all that)? Or maybe the extraordinary public-private partnership with the aforementioned East India Company had something to do with it.

Military domination is undoubtedly part of the reason as to why Asia – at the tech frontier in the middle ages – went into sharp relative decline after the various voyages of “discovery” in the 16th and 17th centuries. If you feel inclined to pursue, Niall Ferguson’s Empire and Shashi Tharoor’s Inglorious Empire offer plenty of uncomfortable truths about politics, power and growth. Combinatorial forces really come into play when you mix armies with steamships, cables, railways, theodolites and maps. Commerce, conquest, colonisation – hard to disentangle when they are working in such harmony.

And we should also recognise, ahead of session 7, that financial institutions are critical to TFP. Indeed many historians cite British and Dutch innovations in the banking, insurance, security and derivatives markets as principal drivers of economic (and military) success from the 17th century onwards; innovations that generally preceded the first Industrial Revolution.

In class we refer to Acemoglu and Robinson’s work on Why Nations Fail and may find time to discuss geopolitical-TFP overlaps such as Brexit and China’s Belt and Road Initiative. Further evidence that macroeconomics cannot escape the grip of institutional context.

25 Feb 2021