Capitalism and Inequality

The Role of State and Market

G.P. Manish, Stephen C. Miller, G.P. Manish, Stephen C. Miller

• Publisher: Routledge
• Year: 2020
• ISBN:
  9781000283921
• Edition: 1
• Topic: Business
• Subtopic: Marketing internazionale
• Index: Business

Capitalism and Inequality rejects the popular view that attributes the recent surge in inequality to a failure of market institutions. Bringing together new and original research from established scholars, it analyzes the inequality inherent in a free market from an economic and historical perspective. In the process, the question of whether the recent increase in inequality is the result of crony capitalism and government intervention is explored in depth.

The book features sections on theoretical perspectives on inequality, the political economy of inequality, and the measurement of inequality. Chapters explore several key questions such as the difference between the effects of market-driven inequality and the inequality caused by government intervention; how the inequality created by regulation affects those who are less well-off; and whether the economic growth that accompanies market-driven inequality always benefits an elite minority while leaving the vast majority behind. The main policy conclusions that emerge from this analysis depart from those that are currently popular. The authors in this book argue that increasing the role of markets and reducing the extent of regulation is the best way to lower inequality while ensuring greater material well-being for all sections of society.

This key text makes an invaluable contribution to the literature on inequality and markets and is essential reading for students, scholars, and policymakers.

1 Capitalism, cronyism, and inequality

Randall G. Holcombe

I. Introduction

Inequality in capitalist economies has been an issue in economics since the beginning of capitalism. Capitalism emerged as a distinct economic system in the 1700s.¹ Pre-capitalist societies were marked with substantial inequality of income and wealth, but that inequality was the result of inherited wealth and inherited status. Some people were born into royalty and nobility and were more prosperous because of their inherited status. Princes were more prosperous than commoners not because of their economic productivity but just by the good fortune of their birth. The emergence of a market economy along with the idea, developed around the same time, of political equality, offered the promise of a more equal society in every way. Thus, while inequality would be expected in a class-based society in which some people, by virtue of their birth, are more privileged than others, capitalism brought with it the idea that people should prosper in relation to their productivity.

While differences in productivity may lead to inequality, two distinct arguments have been advanced to reach the conclusion that capitalism inherently leads to inequality, and that this inequality is not simply the result of differences in productivity but is the result of a system that gives advantages to some over others. One view is that capitalism embodies mechanisms that generate increasing inequality, so that over time incomes and wealth become increasingly unequally distributed, unrelated to individual productivity. Another view is that the economic elite are able to influence public policy to give themselves advantages over the masses. One view does not rule out the other: both could be true. After reviewing these two views, this chapter examines a substantial body of literature supporting the view that inequality is exacerbated by cronyism as the elite are able to manipulate public policy for their own benefit.

II. Capitalism causes growing inequality

As capitalism was in its early stages, Malthus (1798) made the dismal projection that population tends to grow faster than the resources available to support that population, so most people are destined to survive at just a subsistence level of existence. Ricardo (1817) further advanced Malthus’s ideas on the scarcity of resources, noting that while the inputs of capital and labor can be increased, land is fixed in supply. Capital can increase through investment, and population growth increases the labor supply. As population grows, the demand for food increases. The most fertile land will tend to be the first used for farming, and population growth means that farming must occur on increasingly less fertile land. As less fertile land is brought into production, the owners of more fertile land can charge a rent equal to the difference in the productivity of their land relative to the least fertile land that is being cultivated. Ricardo (1817: ch. 2) notes that rent arises only because the quantity of land is limited and is not of uniform quality. He says, “The rise of rent is always the effect of the increasing wealth of the country, and of the difficulty of providing food for its augmented population.”

As population grows, Ricardo argues that rents increase, squeezing profits and leaving workers at a subsistence level of income. The declining profits slow economic growth as a greater share of income goes to landlords, leaving little for investment and eventually leading to a stagnant economy. Ricardo (1817: ch. 6) observes:

Long indeed before this period [when the economy stagnates], the very low rate of profits will have arrested all accumulation, and almost the whole produce of the country, after paying the labourers, will be the property of the owners of land and the receivers of tithes and taxes.

In Ricardo’s view, wages had to be paid to labor to get people to work, and capital had to earn a profit to get people to invest, but land would be just as productive regardless of the rent paid to it, and regardless of whether it earned any rent at all. Rent does not need to be paid to land to get it to be productive, according to Ricardo, so the growing inequality due to the increasing share of national income going to land owners is unrelated to the productivity of those land owners, and accrues to them only because the capitalist system allows ownership of land and allows land owners to collect rents.² Ownership of the means of production – in this case, land – is a feature of capitalism that generates growing inequality.³

In Ricardo’s analysis, growing income inequality is an inherent feature of capitalism, arising directly from the private ownership of land. Ricardo (1817: ch. 1) began his book with a chapter, “On Value,” in which he laid out his labor theory of value.

The value of a commodity, or the quantity of any other commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production, and not on the greater or less compensation which is paid for that labour.

Ricardo’s ideas were extended by Marx (1906), who argued that if the value of a good is equal to the value of the labor embodied in it, the entire sales price of the good should be paid to laborers. Capitalists are able to exploit labor because of a monetary economy in which labor is sold for money and goods are also sold for money. The capitalists receive the money that is paid for goods but only pay part of it to the laborers, keeping the rest for themselves as surplus value. Capitalism allows this exploitation because capitalists own the capital and therefore control the jobs. Capitalists are not producing anything – the laborers are, following Ricardo’s theory of value – but they receive their incomes by taking what rightfully belongs to the laborers. Capitalism, by its nature, naturally generates inequality.

More recently, Piketty (2014) drew the same conclusion that the private ownership of the means of production inherently generates increasing inequality. Capital ownership is not equally distributed, Piketty notes, but is heavily concentrated at the top of the income distribution. The top 10% in the income distribution own most of the capital, and those in the bottom 50% own almost none.⁴ The incomes of wage earners grow at the same rate as GDP, a growth rate that Piketty labels g. Capital income grows at the rate of return on capital, r, and Piketty notes that r > g, so he concludes that the upper end of the income distribution, which receives the capital income growing at r, will see their incomes rising faster than the incomes of most people whose incomes grow at g. Because of the private ownership of capital, the observation that r > g means that capitalism, by its very nature, generates an increasingly unequal distribution of income.⁵

The staunchest defenders of capitalism acknowledge, and even celebrate, the fact that capitalism results in income inequality. Some people are more productive than others, meaning they contribute more to other people’s well-being, and they are compensated more because of it. The theories of Ricardo, Marx, and Piketty are different because the marginal productivity theory of income suggests, from a normative angle, that the people with the higher incomes deserve them because they contribute more to everyone else’s well-being. Those who earn more income in the analyses of Ricardo, Marx, and Piketty do not receive their higher incomes because they earn them, but rather because they happen to own the means of production.

In one of the most moving sentences in the economics literature, John Stuart Mill (1848: 208) flirts with the idea of communism, saying:

If, therefore, the choice were to be made between Communism with all its chances, and the present state of society with all its sufferings and injustices; if the institution of private property necessarily carried with it as a consequence, that the produce of labour should be apportioned as we now see it, almost in inverse ratio to the labour – the largest portions to those who have never worked at all, the next largest to those whose work is almost nominal, and so in a descending scale, the remuneration dwindling as the work grows harder and more disagreeable, until the most fatiguing and exhausting bodily labour cannot count with certainty on being able to earn even the necessaries of life; if this or Communism were the alternative, all the difficulties, great or small, of Communism would be but as dust in the balance.

Mill’s observation squares with the observations of Ricardo, Marx, and Piketty, that the capitalist system produces not only an inequality of income but also an unfairly unequal distribution of income. Ultimately, Mill concludes that the institutions of capitalism can be modified so that these unfairly unequal outcomes can be addressed, but Mill’s observation shows the perception of unfairness in the distribution of income in 19th-century capitalism.⁶

III. Institutions and inequality

In contrast to the view that capitalism inherently generates inequality, many observers conclude that inequality is the product of political institutions. The economic and political elite work together to design institutions to provide them with advantages over the masses. Mill’s analysis hints at this, because while the preceding quotation shows his observation about the current state of affairs, he believes that institutions can be restructured to preserve the private ownership of property and also produce a fairer distribution of income. Mill (1848: Book II, ch. 1) says:

The laws and conditions of production of wealth partake of the character of physical truths. There is nothing optional or arbitrary about them…. It is not so with the distribution of wealth. This is a matter of human institutions solely. The things once there, mankind, individually or collectively, can do with them as they like.

One can debate the degree to which Mill’s analysis is correct. One can conjecture that if mankind collectively decides “From each according to his ability; to each according to his needs” (Marx 1875), people would have little incentive to produce, so the “laws” of production may depend on the laws of distribution. A larger point in Mill’s analysis is that the distribution of income is dependent on the institutional framework within which it is produced. As the early institutionalists observed, capitalism is based on a set of institutions that define and protect property rights and specifies what individuals are allowed to do with their property and what they are prohibited from doing with their property. The distribution of income ultimately is determined by those institutions.

Commons (1924, 1934) emphasizes the way institutions affect all economic outcomes, and de Soto (1989, 2000) shows the effects of institutions on economic outcomes by comparing the institutional structures of less developed with more developed economies. Consider the limited liability corporation, which facilitates equity financing by limiting the risk of the owners of businesses. This has facilitated corporate growth and enabled corporate managers to use the corporate governance structure to increase their incomes relative to other workers lower down in the corporate hierarchy.⁷ The regulatory state prevents people from using their property in productive activities they might otherwise choose, sometimes through an explicit prohibition on entry (as with New York taxis) and sometimes through regulations that create a barrier to entry and protect the markets of incumbent firms. Antitrust laws and labor laws govern what businesses are allowed to do and conditions under which people can hire out their labor.

Consider another straightforward example: the legal protection of intellectual property. People can copyright software code and patent formulas for medical drugs, giving them a government-granted and enforced monopoly over the use of those ideas. Fashion designs cannot be copyrighted or patented, nor can recipes for preparing food. If someone designs a new software program or a new drug, government gives the designer an exclusive monopoly right to the intellectual property the person has created, but if someone designs a new fashion line or a new recipe, that intellectual property is not patentable or copyrightable under current law and can be copied by anybody who sees it. Institutional design sometimes gives ownership of intellectual property to its creator and sometimes allows anyone to make use of ideas once they are created. These institutional differences affect the income-earning ability of those who do, or do not, have government-assigned and enforced property rights.

Economists are often prone to depict economic activity in equil...