Inequality in Financial Capitalism

Pasquale Tridico

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781317372097
• Edition: 1
• Topic: Commerce
• Subtopic: Commerce Général

Recently, the issue of inequality has regained attention in the economic and political debate. This is due to both an increase in income inequality, in particular among rich countries, and an increasing interest in this issue by researchers and politicians. In the last three decades, income inequality among rich countries increased. This period also witnessed the growth of "financial capitalism", characterised by the strong dependency of economies on the financial sector, by the globalisation and intensification of international trade and capital mobility, and by the "flexibilisation" of labour markets and the reduction of wage shares.

From the 1980s to the present day, this book considers the theoretical aspects of inequality (its foundations, definitions, approaches and origins) and examines empirical evidence of income inequality in a wide range of advanced economies. The key arguments in this volume are that income inequality increased during this period because labour and welfare became seen as costs to be compressed in "financial capitalism" rather than as a fundamental part of aggregate demand to be expanded. However, the welfare state is not a drain on economic performance and competitiveness, nor is it a barrier to economic efficiency. Instead, it is demonstrated that in countries that adopt "welfare capitalism", welfare state expenditure not only contributes to a reduction in inequality but also fosters economic growth.

Inequality in Financial Capitalism is of great importance to those who study economics, political economy, labour economics and globalisation.

Part I
Definitions, approaches and origins of income inequality

1 Theories, methods and varieties of inequality

The social origins of inequality

The very foundation of the problem of inequality is the concept of social welfare. According to the utilitarian approach, social welfare is the sum of individual welfare. Social welfare improvements are not possible (or would not be “Pareto efficient”) by re-distributing resources from one individual to another, because a “Pareto” improvement is a situation in which it is impossible to make someone better off without making someone else worse off. On the other hand, an egalitarian approach would consider re-distribution of resources to avoid the situation where an individual could become richer by taking advantage of the fact that the other is in poor health or in poor education or is handicapped (Sen, 1973). In this latter approach, the application of the Rawls’ criterion would be the best policy; the aim is not individual welfare but the level of welfare in the society. If one individual (A) has a lower level of welfare than another (B), and if B can be made better off by re-distributing resources from A, then the Rawls’ criterion of justice requires that B should have sufficiently more income to make B’s utility equal to A’s. In Rawlsian thinking, inequalities have to be adjusted by following two principles: (1) offices and positions must be open to everyone under conditions of fair equality of opportunity, and (2) they have to be of greatest benefits for the least-advantaged members of the society (Rawls, 1971: 303). To be applied, these criteria require more than meritocracy. ‘Fair equality of opportunity’ requires not only that positions are distributed on the basis of merit but also that all have equal opportunity, in terms of education, health, etc. to acquire those skills on the basis of which merit is assessed. The application of these principles would, in the end, produce much greater advantages for the society as a whole.

Another way to look at the problem of inequality is through social peace and cohesion. Sen (1973) saw inequality as strictly linked to the concept of rebellion, and indeed the two phenomena are linked in both ways. Inequality causes rebellion, but it may happen that income inequality may increase after a rebellion where it brings power to a specific apparatus or a nomenclature or a social class; this has happened many times in history when, for instance, rebellions were led by army generals or by elites of nobles. In several transition economies, inequality increased after a “rebellion” that brought to power oligarchs. In particular, in the former Soviet Union, inequality increased dramatically after the 1991 August Coup, which deposed Soviet president Mikhail Gorbachev and dissolved the URSS. In some African countries, such as Congo and Sudan, the same happened: rebellions, carried out by generals and warlords, deposed previous authoritarian or less authoritarian regimes, but such a change brought about an increase in inequality. Nowadays, economists try to capture a causality nexus (inequality → rebellion → inequality) through the use of some modern governance indicators such as political stability. The link between political stability and inequality is demonstrated in numerous empirical works such as Alesina and Perrotti (1996) and Easterly (2001), where it emerges that income inequality increases during political instability.

An interesting explanation of inequality in the Americas is put forward by Sokoloff and Engerman (2000), who, in order to explain inequality in wealth, human capital and political power, suggest an institutional explanation, historically founded, which lies in the initial roots of the factors of endowment of the respective colonies. In general, political institutions set up by the Spaniards and Portuguese in Latin America were different from the ones set up by the British in North America. Moreover, the latter sent educated people and skilled work forces, along with the lords, to the New World, and these started to build their own future; while the Spaniards and the Portugueses did not encourage massive migration from the motherland but sent landlords who basically exploited slaves from Africa.

One of the first cross-country works on inequality was made by Kuznets (1955). He showed that in the early stage of economic growth income tends to be unequally distributed among individuals. In the early stage of a growth process, over time, the distribution of income worsens. In the later stages, national income starts to be more equally distributed. Hence, inequality declines in the end, after the country has accomplished the U-shaped trajectory. Several later empirical studies confirmed this relationship (Chenery and Syrquin, 1975; Ahluwalia, 1976). The reason for such a relationship was attributed to structural changes, which at the beginning of the “transition” brought about job losses and inequalities.

Nevertheless, the implicit trade-off behind the Kuznets’ curve (economic growth/ inequality) and the idea that an increase in inequality is sometimes necessary for a rapid growth has been often criticized (Atkinson, 1999). Milanovic (1994) puts forward n alternative hypothesis to explain why income inequality differs among countries; he shows that inequality decreases in richer societies because social attitudes towards inequality change as those societies get richer, and inequality is less tolerated. Birdsall and Sabot (1994) showed, contrary to the Kuznets’ hypothesis, that inequality may be a constraint for growth and, if inequality is lowered, then a country could have a GDP per capita 8.2 per cent higher than a country with income inequality 1 standard deviation higher.

Voitchovsky (2005: 273) suggests a similar hypothesis, however, stressing the shape of the distribution and suggests that inequality at the top end of the distribution is positively associated with growth, while inequality lower down the distribution is negatively related to subsequent growth. Moreover, empirical evidence in cross-countries analysis, from Latin American to East Asian Countries, pose the question why Latin America has high inequality and low growth and, on the contrary, why East Asia has high growth and low inequality. Birdsall and Sabot (1994) suggest that it is a matter of policies and social attitude towards inequality. In Latin America, dictators, generals and the ruling classes acted, for long time after World War II, with little respect for the poorest part of their society, implementing fiscal and trade policies that provided little benefits to the poor. On the contrary, in East Asia, the ruling classes were more aware of social needs and implemented policies such as land reforms, public housing, public investments in rural infrastructures and public education, which had a positive effect on both growth and income distribution; better educated people can get a better job and earn more; public investment in the rural sector can bring farmer productivity and income higher; public housing and other social services can increase the purchasing power of people; and so forth.

Varieties of (economic) inequality

The concept of inequality, which in most cases interest economists, is the inequality of opportunity and the inequality of outcome. Roughly speaking, the first type of inequality has to do with the “external circumstances”, which are beyond the personal control of individuals and allow for a disadvantage of an individual with respect to another (Atkinson, 2015). They concern family background, social context, and similar. The inequality of outcome concerns instead “internal circumstances” of an individual, such as efforts, skills and similar and for which the individual is (supposedly) responsible.

Neoclassical economics in general neglect economic inequality since it is considered neutral with respect to economic performance. First of all, because neoclassical models analyse (people) compensation in terms of factor of production compensations so that incomes go to factor labour and factor capital according to their shares (which is supposed to be constant in the long run)¹ and to their prices, which is supposed to be affected by the demand and supply, hence by “external” forces. Thus, income distribution is “functional” to the trend and forces of the economy so that if for some reasons demand of capital increase, its prices (profits) go up while labour demand decrease and wages decrease; if demand of capital decreases, profits decreases and wages increase. Labour and capital are supposed to be substitute and their prices flexible so that market forces (demand and supply) allow for continuous adjustment and equilibria with full utilization of resources (no unemployment).² If, however, neoclassical economics were to consider between persons’ compensations rather than merely factor of production compensation, the whole picture would change. Inequality would immediately appear not only between shares (of labour and capital) but also within shares (among workers, among people and within the society). In this way, also the utilitarian approach, at the basis of the neoclassical mechanism of functional distribution, would be questioned since the interpersonal sum of income (among some bottom group of the society) would be disadvantageous for some groups with respect to others, although the total sum of the income would be the same in the society.

Some economists (Deaton, 2013), however, are interested in the inequality of opportunity as they consider this morally and socially wrong. Other economists, in particular in the last years, further call the attention on the inequality of outcome and the possible remedies against that (Atkinson, 2015; Piketty, 2014). There is a strong justification for this purpose, which is also the justification of this book and its main guide.

First of all, people’s lives are not only affected (ex-ante) by family and social context but also (during job and school) by luck, accidents and similar things that would justify ex-post adjustments for both equity and macroeconomic reasons (I shall come back on the macroeconomic reasons later).

Second, rewards for some works and professions can be over (or under) priced and therefore over (or under) compensated by some political forces that act in a particular moment and context so that inequality among people would increase unjustifiably, beyond the traditional neoclassical argument of marginal productivity. This is not only a matter of imperfect competition, as it occurs with mark-up in some sectors, but it is crucially due to the specific economic model and the political paradigm that would allow for a biased income distribution in favour of a particular lobby and of a specific economic sector. This is the case of the financial sector which, within the financial capitalism model, gets all the advantages of economic growth beyond marginal productivity justification (at least in the long run). This is also the main focus of this book, so we shall come back to this central issue.

Third, as Atkinson (2015) argued inequality of outcome crucially influences future inequality of opportunity, so that individuals and families, which are allowed by the already biased and unjust circumstances listed above to gain extra compensation and to become richer, will affect future initial conditions of their children with greater advantages with respect to other children, so that Atkinson concludes, “If we are concerned about inequality of opportunity tomorrow, we need to be concerned about inequality of outcome today” (Atkinson, 2015: 11).

Fourth, the relevance of power and of politics that is crucially shaping the dimension of inequality through formal rules, power and institutions set the “rules of the game”, which affect income distribution such as minimum wage, welfare support, or rule concerning (de)regulation for specific sectors, such as finance, anti-monopoly rules, and or support for specific sectors, such as export-oriented sectors and agriculture subsidies.

Economic inequality is usually defined in terms of income inequality and it is captured by differences in incomes, in factor compensations, wages, and money. However, inequality is much more than that. It includes inequality of access to resources, inequality in education, social inequality, class inequality, political inequality, etc. (see De Muro, 2016). These types of inequality, contrary to income inequality, are difficult to measure, so economists usually prefer to deal with the latter. However, very often, at the basis of income inequality, there is the inequality exactly of those types listed above (Bastia, 2013). Similarly, following the Fraser (1995; 2005) analysis, inequality is a combination of three material and immaterial dimensions in the context of globalisation; these dimensions are as follows:

1 Representation (political dimension)

2 Redistribution (economic dimension)

3 Recognition (...