TheMarketForIdeas

The issue of labor in contemporary Economics and society is a very interesting one. First of all, the rapid changes such as the accelerated evolution of technology and the emergence of new economic paradigms have radically influenced the vision on labor. Secondly, with all of these changes, some positive, labor still faces many issues, some of which are very old, such as forced labor or even slavery – even now, with its contemporary forms – and some which are a direct result of modernization, such as low job matching efficiency or welfare systems. These are related to another set of problems, which go hand in hand with those of labor, namely inequality issues, especially those of an economic nature.

Thus, the structural problems of the labor market, albeit not alone, are seen as one of the main causes of economic inequality. Various other issues need to be considered in conjunction with the field of labor economics, be they pragmatic, such as wealth concentration; ideological, such as the decline of unions or the failure of classical economic liberalism; and even of an epistemological nature, such as the fairness versus equality dilemma.

Many answers have been given to these problems, as well as to their causes, from the most optimistic ones, focusing on mitigation, to more pessimistic answers, such as the Malthusian argument. However, while currently lacking a definitive solution, the effects at the level of both labor and economic inequality are very visible. These are mostly reflected in the area of ​​welfare, which can no longer keep up with socio-economic challenges, but also around social cohesion, civic participation and even political instability, all severely affected by the problems of labor and economic inequality. 

Background and conceptualization 

In the face of these realities, economic inequality and wealth concentration, as well as the responsibility of governments to address them, are continuously disputed in the mainstream political and academic landscapes. Among those who believe inequality to be a rather trivial problem in the face of poverty, Martin Feldstein holds that, in the long run, economic development tends to benefit almost everyone. Likewise, Joseph Schumpeter noted that “the capitalist achievement does not typically consist in providing more silk stockings for queens, but in bringing them within the reach of factory girls [...]”. For others, however, inequality – defined as the disparities between the income levels of the richest and those of the poorest – is considered to be one of the most resounding failures of capitalism and free markets.

The key inequality-related discussions in modern economic literature began in the 1950s, with Simon Kuznets’ “inverted-U hypothesis”, which maintains that relative inequality increases are a natural phenomenon in the early stages of economic growth, improving once countries reach middle-income levels. Similar discussions on whether the world has become more or less unequal have followed all throughout the twentieth century to today, revolving around two key concepts: income and wealth, with different results depending on which of the common concepts of income inequality was used as a benchmark. Therefore, in recent decades, whereas the income gap between countries has narrowed down and the global distribution of income has become more equal, mostly due to the high rates of growth of highly populated countries such as India and China, within-country inequality – i.e., the difference between the incomes of the rich and the poor within the same nation – has gone upwards.

Among the biggest challenges in terms of the conceptualization of economic inequality was finding a method for quantifying it. The first attempt came in 1905 from the American economist Max Otto Lorenz, who devised a graphical method of measuring inequality in the area of ​​wealth distribution. The method, called the Lorenz Curve, which shows the proportion of wealth accumulated by a percentage of the population, is still used to represent income distribution, often pointing to social inequality. The Lorenz Curve was based on the vast majority of inequality measurement methods, such as the Gini Index, the Palma Ratio, the 20:20 Ratio, the Hoover Index, the Galt Score, the Theil Index or the Atkinson Index.

But in 2013, in the article “Global Income Distribution: From the Fall of the Berlin Wall to the Great Recession,” Christoph Lakner and Branko Milanovic developed the so-called “Elephant Curve.” It starts with the bottom 10-15% of the population, which have had the lowest income growth in poor countries, and which will not have much chance of increasing their income, due to low economic conditions inherent to the status quo. From here begins the elephant’s tail, which stretches up to 50% in an upward curve, outlining the elephant’s body. Then follows the section between 50% and 60%, where the curve rises in a sharp spike, representing the elephant’s head. In this area are found the developed countries, the lower and middle classes. They, unlike the other segment of the population, may have the opportunity to increase their income, due to a favorable economic context. More specifically, the segment between 50% and 60% is represented by countries with rapid economic growth, initially in the class of developing countries, namely China and India.

After 60%, the downward shift represents the first piece of the elephant’s trunk, which continues up to 80%. This decrease accounts for the upper-middle class, which did not register any considerable increase in income during the 1980s. From this point and up to 100%, the curve resumes its upward direction, to represent the lower portion of the elephant’s trunk, with a last ascendant movement between 99% and 100%. The last 20% of the curve represents the global elites, who have experienced a significant increase in income, while the income of the top 1% has grown continuously, without any decrease.

On the other hand, in the 2003 article “Income Inequality in the United States, 1913-1998,” Thomas Piketty and Emanuel Saez concluded that, in the period of 1979-2003, income inequality increased on the basis that the top 10% took 90% of income growth, and while the incomes of the top 10% increased, those of the remaining 90% stagnated. In 2013, Piketty and Saez, together with Lucas Chancel, Gabriel Zucman and Facundo Alvaredo, published “The Elephant Curve of Global Inequality and Growth,” in which they readjusted the Lakner-Milanovic curve. There were two major changes: firstly, the data from the World Inequality Database, from the École d’économie de Paris, was used for a wider statistical base; and secondly, the reference period was changed from 1988-2008, that of Lakner-Milanovic, to 1980-2016. Thus, in the new variant, the middle of the curve was at 40%, with an increase of 43%; the top 10% had increased 70%; and the top 1%, an increase of 101%. However, the analysis went further in trying to prove that a percentage of 0.001% had an income increase of 235%.

Therefore, by the second decade of the second millennium, new approaches to conceptualizing and measuring inequality over time and across countries disproved the “inverted U-shape” pattern predicted by Kuznets, as well as the hypothesis that inequality declines once countries reach economic maturity, giving room to both opposing and updated versions of his theory. However, one thing that is almost unanimously agreed upon today is that, despite the different methods of quantification, since the 1980s, all advanced nations have witnessed increasing inequality levels.

It is against this backdrop that we will explore two of the most pertinent retrospective analyses of income inequality in empirical economic literature: the work of Thomas Piketty and Emmanuel Saez, and that of Cristoph Lakner and Branko Milanovic, respectively. Our comparative analysis will be conducted strictly from the point of view of the composition of their arguments and their measurement of economic inequality in terms of income and resources, ideologically objective and untouched by the nostalgia of the moral or socio-political justifications of equality, derived from Rousseau’s ontological equality or from Rawls’ theory of social justice. 

Clashes 

First, Piketty and Saez’s empirical findings shook the world with the evidence that the Kuznets curve had in fact “doubled back” on itself, taking on a U-shape. Documenting the sharp contraction in high-income inequality between 1914 and 1945, Piketty’s work centered around the hypothesis that it was exceptional – and therefore temporary – historical circumstances, such as the Great Depression and the two world conflagrations, that reduced top fortunes, sparking the “leveling” of top incomes and the subsequent dramatic inequality reduction that justified Kuznets’ optimism.

Seen from this lens, the early 1950s peak of the declining share of high-income concentration previously witnessed during the “Gilded Age” is merely a reflection of the rise of the welfare state, echoing the broad post-war consensus that tackling inequalities fell within the responsibility of governments. The story Piketty tells about the political and ideological determinants of inequality can be inferred from his observation that the Americans’ inability to accumulate (new) fortunes in the aftermath of the war was not a sign of economic stability, but a direct result of the introduction of tight financial regulations and extremely progressive income and estate taxation through the New Deal. Likewise, the tax cuts performed by the Reagan administration are seen as the main cause of the rise of the top 10%’s income share in the 1970s. However, according to the two authors, with the goal of radical redistribution slowly starting to be abandoned, the major privatization and liberalization of financial markets brought a significant contribution to the upward turn of the inequality curve.

Unlike Piketty, Milanovic holds that, over centuries, inequality has experienced a regular rise-and-fall pattern. In an effort to update Kuznets’ perspective, the Serbian American economist referred to these fluctuations as the “Kuznets waves,” the first wave beginning with the transition away from agrarian societies to an industrialized world, and the second wave, with the emergence, in the 1980s, of a new type of capitalism – tertiary, digital and financialized, and above all, more globalized.

ndeed, wars, crises and redistribution have been well inventoried by Piketty and many other researchers. However, the novelty of Milanovic and Lakner’s analysis and foresight consisted in a raft of new questions about inequality, globalization, and choices of an imagined global citizenry, integrated in the causal chain behind the famous elephant curve, reflecting the world income distribution during the “intense globalization” period of 1988-2008.

In this respect, the two authors suggest that, from the beginning of the Industrial Revolution through the second wave, the cycles of rising and falling inequality have been influenced by three dominant and entangled economic forces: technology, openness and politics. To these, Piketty and Saez counterpose the differences of inequality levels across countries (e.g., continental Europe vs. English-speaking countries) to argue once again that, in fact, the main drivers of inequality are rooted in ideology and politics.

It is above all through his concern to “endogenize” the drivers of inequality trends that Milanovic’s reasoning differs from – while seeking to complete – Piketty’s analysis, which focuses on the idiosyncratic and “exogenous” nature of the shocks that occurred between 1914-1945. In addition, Milanovic notes, the downswing portion of the first Kuznets wave reflected the impact of not only “malign” factors (that is, wars, crises and epidemics), highly recurrent in Piketty’s writings, but also of “benign” causes (i.e., improved education, migration, redistribution, social rights and the creation of welfare states) and the impact of their interaction on the relationship between labor and capital.

Finally, whereas in Piketty’s work, inequality-reducing forces come largely from outside the economic field (whether it was war-torn destruction or democratic mobilization), they are here conceived within – and delimited by – the economic field. In this sense, Milanovic follows Hobson’s logic to portray the First World War as a conflict of economic interests, driven by the domestic maldistribution of income and the businessmen’s need for profit, which forced governments to push “for markets, investments, and concessions outside their own country” (Hobson, 2013, pp. 492‐3) and try to grasp control of outside territories favorable to foreign investment.

Where both Piketty and Milanovic converge is that inequality is a natural consequence of capitalism. Perhaps with the exception of Lakner, Senior Economist in the Development Data Group at the World Bank, whose position on capitalism cannot be questioned, the aforementioned economists propose an institutional approach of the policy area. Saez, for one, is a neo-Keynesian economist, influenced by Sir Anthony Barnes Atkinson, in turn a student of the Nobel Prize in Economic Sciences winner, James Edward Meade. In his work, the French economist often addresses topics such as capital income taxation or the marginal tax rate, connecting and researching the links between income and tax policies.

Thus, Saez tried to contribute to the transposition and quantification of the characteristics of fiscal policies, for a better applicability in the area of ​​economics and economic behaviorism. The reason for his receiving the John Bates Clark Medal in 2009 and the MacArthur Fellowship in 2010 was precisely his success in transforming the area of ​​taxation theory into a more applicable form of fiscal and taxation policy.

In his book, “Capitalism, Alone: ​​The Future of the System That Rules the World,” Milanovic begins by depicting the global status quo, namely the fact that the entire planet is ruled, primarily, by a single economic system, namely capitalism. His oeuvre goes both through the evolutionary historical background and through the variations of capitalism. The conclusion remains that capitalism is “alone” at the moment, and although it makes many mistakes, it does not seem to have any credible alternative at this time.

Thus, Milanovic emphasizes that capitalism can be improved through the policy area. He explains that the reason for its singularity is that, until now, in a more or less efficient way, capitalism has worked, especially because it offers autonomy. On the other hand, it adopts materialism as the ultimate and finite goal, and does not offer stability. Certain policies are needed for each area to improve the situation. In the case of the West, capitalism fails in the face of inequality. In the case of China, the model of capitalism is more prone to internal problems such as corruption and can even reach social unrest. Finally, the Global South has specific economic problems, and here Milanovic’s policy is represented by a migration plan – a rather controversial one. However, the crux of his analysis boils down to the fact that capitalism needs to be improved.

In his opposite magnum, “Capital in the Twenty-First Century,” Piketty analyzes the evolution of wealth and income inequality in both Europe and the United States, beginning in the eighteenth century. Piketty sees economic inequality not as a coincidence, but as an inherent consequence of capitalism, and even advances the solution of state interventionism. He is also aware that this answer, just like the flaws of capitalism, can lead, in the long run, to a systemic threat to democracy. Regarding inequality, Piketty holds that the current status quo illustrates the continuity of its ascending trend, contracted in the immediate post-war period precisely by state interventionism and the redistribution of wealth. This led to strong economic growth, diminishing the importance of what Piketty calls “patrimonial capitalism,” generally resulting from inheritance.

At the moment, patrimonial capitalism has returned to an important position, and the power of economic elites tends to create a rigid, oligarchic class, thriving on accumulated capital, similar to the economic situation of Western Europe at the beginning of the 19^th century. The solution proposed by Piketty is the progressive taxation of the global wealth, reaching up to 2%, and a progressive income tax, reaching up to 80%. However, he acknowledges that, although the solution would indeed reduce inequality, its applicability today is politically impossible. In the absence of reforms, however, economic growth will slow, mainly because investment returns are above income based on productivity, and inequality will continue increasing. Last, but not least, he denies the hypothesis that technological advancement will generate a burst of high economic growth. 

Criticism 

There are many opinions that Milanovic-Lakner’s “elephant” in the inequality room has some fundamental problems. The first is that of the stagnating segment between 60% and 80%, found in developed countries such as the United States or Western Europe. The conclusion that Milanovic draws from this is that, in the time-period analyzed, marked exactly by the acceleration of global trade and investment, the “villain” is none other than globalization. However, studies suggest that, during that period, in the countries from the presented segment, the majority of the population experienced an increase in income.

The argument is taken further: it is said that the positive effects of globalization have led to changes in the lower segments of the graph. This line of reasoning stems from the rise of China, as well the rise of the global living standard, not properly quantified by the “elephant curve.” Criticism continues with the fact that the accentuated portrayal of the two extremes of the curve shows, on the one hand, a false lack of progress, and gives the impression that, in countries with low incomes, economic growth can occur only at the expense of high- and medium-income countries. In addition, even the shape of the “elephant” itself is disputed in terms of adaptation to a time axis, because it does not seem to consider elements such as the fall of the Soviet Union, the Asian Financial Crisis resulting in Japan’s stagnation, or policy changes in countries such as the United States or the United Kingdom.

Criticism is not lacking in the case of Piketty-Saez’s studies either. Thus, what is reproached to their 2003 joint study is that the proposed data sets are pre-taxation, and not post-taxation, as well as the fact that they offer a gross approach of tax income. Critics believe that this creates a distorted picture of reality, because it fails to account for how much the rich pay, compared to how much of their income people from low and middle lose after taxation. Consequently, the accuracy of their analysis is significantly affected.

Another critical insight is that, in their study, Piketty and Saez prefer to use income tax data and not survey data. In fact, Piketty-Saez gave birth to a literature that no longer relies on classic data, such as survey or census, to report income distribution and inequality, but on tax data. However, both methods have their problems, starting from the fact that, when it comes to surveys, there is a tendency of underreporting from the “upper” area, while in the tax data, we try to reduce the reporting at a general level to avoid tax liabilities. Therefore, a hybrid between the two data types is recommended.

Authors such as Randall G. Holcombe and Deirdre N. McCloskey are also dissatisfied with Piketty’s proposed remedies to inequality, which rely on a much larger government presence to monitor and collect the taxes he recommends. The issue highlighted here is that, in the United States, the pervasive welfare payments and tax breaks for the very rich have in fact favored the top of the ladder, allowing for the counterview that the government, which Piketty expects to tackle these imbalances, is in fact their very cause. This criticism is related in particular to the American Tax Relief Act of 1986, which facilitated attempts to reduce taxes for the high-income bracket. Moreover, in response to Piketty’s idea of a global wealth tax, or at least an EU-wide tax, designed to block capital flight to low-tax regions, these authors warn that such institutions may fall prey to rent seekers, and that immunity from capture by the 1 percent cannot be guaranteed.

Last but not least, despite the great importance that Piketty attributes to political trends in explaining the evolution of inequality, in his analysis of the growth in the capital-output ratio, the French economist fails to account for its likely political effects. But one other very interesting point of view we might want to keep in mind is that Piketty’s and others’ purely economic interpretations cannot extend enough to cover the different patterns of collective action – i.e., why and when the remaining 99% tolerate or react to capital accumulation – in the face of “the institutional order in which capitalist development unfolds” (Hopkin, 2014). Moreover, economists tend to overlook the impact of the evolution of social norms on the widening of inequalities, especially since, at times, such gaps seem to be not only tolerated, but encouraged.  

Conclusion 

The two perspectives that made the subject of our scrutiny differ both in terms of the explanations for the dynamics of inequality, and in terms of methodology. For Milanovic, the low levels of inequality witnessed at a particular point in history are nothing but the trough of a recurring wave, while for Piketty, such moments constitute a large, sustained, but unusual deviation from the rising upward trajectory of inequality under capitalism. However, whether they assume that it is rather impersonal forces, such as technology or globalization, or political agency, that constitute the main drivers of inequality, the two economists agree that inequality is inseparable from the flowering of capitalism.

All in all, the recent work of Piketty and Saez, and that of Lakner and Milanovic, have opened up a very promising field of study, arousing great interest among a wide audience, despite the difficulties and limitations outlined above. Indeed, the fact that inequality has been high for most of history explains their pessimism, begging the question of whether the mobilization of endogenous forces would succeed in curbing and checking the increase in income inequality under capitalism. While Piketty and Milanovic emphasize the crucial role of governments in reducing income disparities, through their fiscal and social policies, naturally, the idea of state intervention attracts many critics, leading many researchers to think outside-the-box. 

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Illustration: Painting by Giovanni Boldini (1842-1931), Celebration scene at the Moulin Rouge, Paris (Vers 1889), Paris Orsay. Photo Source: flickr.com