Poisonous tendencies

Cross-posted on  Brave New Europe.

Anyone that has tried to balance a seesaw – not touching the ground – knows about equilibrium. We know how to adjust our position to correct any movement away from perfect balance. The seesaw fluctuates and we cannot relax, but if we react correctly it never moves far from the desired equilibrium state. Next time you balance on a seesaw, take a moment to ponder how you are part of a negative feedback loop – bringing equilibrium to an unstable system. In this context negative is good.

© www.cohenbaum.com

Economists believe that such negative feedback loops are everywhere. The most basic of all is the mechanism of price – prices rise and fall balancing supply and demand, steering the market towards a stable equilibrium. If we set the market free, then `forces’ – penguins on a seesaw or the invisible hand in the economy – will lead us to a happy place called equilibrium – the best of all possible worlds given the constraints. The idea is simple and has become a foundation stone on which the whole edifice of neoclassical economics and neoliberalism is built. The problem is, it is often wrong. The economy is not an equilibrium system at all. There are inputs like energy and losses as goods are consumed. There is no reason to expect that the feedback loops are negative and will lead us to equilibrium. If we do not regulate the forces, we are just as likely to end up in a dystopian world of worker exploitation and environmental destruction, where a greedy elite accumulate all the resource.

Equilibrium thinking is dangerous in economics. When it fails, the consequences are disastrous. Think of a bubble – tulip mania, railway mania, Japanese real estate, the German Neuer market – they happen often. In a bubble, the feedback loop inverts – rising prices drive prices higher, pushing us away from equilibrium until something breaks. Think of climate. Energy is the driver of economic activity – burning fossil fuels produces growth demanding more fuel producing more growth. This is a positive feedback loop that will eventually destroy the stability on which economy relies. Equilibrium thinking cannot explain what is going wrong. Are bubble people behaving irrationally, possessed by some extraordinary delusion, singing There’s a good time coming boys? Are people buying diesel behaving irrationally, dismissing energy as just an externality? No! Whether a bubble or climate, market failure is an intrinsic property of the market – instability is an intrinsic property of non-equilibrium systems – and we need to do something about it.

What about inequality? Are we safe to apply equilibrium thinking here? If we leave it to the market, what is the equilibrium distribution of wealth and income? Strangely, given their equilibrium world view, this question is somewhat taboo in economics. Neoclassical economist Robert Lucas (Sveriges Riksbank Prize in Economic Sciences in memory of Alfred Nobel winner in 1995) said in 2004:

Of the tendencies that are harmful to sound economics, the most seductive, and in my opinion most poisonous, is to focus on questions of distribution.

A problem for equilibrium economists is that questions of distribution are another example of a positive feedback loop that lead to market failure. People with capital accumulate more capital. Unless we impose an appropriate negative feedback loop, the seesaw collapses and resources flow towards one end.

Fortunately not all economists were afraid to drink from Lucas’ poisoned well. Notably, the French economist Thomas Piketty and colleagues have amassed an enormous quantity of data on how wealth and income distributions have evolved over time, see e.g.  Piketty’s Capital in the 21st century. From the data we learn that if the negative feedback loops are too weak, inequality rises inexorably until there is a crisis, economic or political. Without negative feedback, the unregulated free market leads us towards an unstable dystopia. The solution may be unpopular but is relatively straightforward.  Both the historical data and economic modelling tells us that stabilising the distribution requires progressive taxation, preferably capital taxes.

To demonstrate this below I compare real data and a simulation. The black dots show the income share of the 1% in the UK over the last 70 years. Note that it is either falling (up until 1980) or rising (thereafter) but never seems to reach a stable equilibrium level. We can simulate the distribution using agent-based modelling. Agents may be chosen to mirror the full diversity of human behaviour from rational to irrationally random, from individualist to collectivist, from lemming to contrarian, from producer to consumer. Into the model we add growth in the money supply, the distinction between income and wealth, and the return on capital. The line shows the result of my rationally-random agent-based model, where tax policy is changed in 1980. Although the model is too crude to capture shocks such the global financial crisis, it does reproduce the long-term trends. Whether my crude model or more sophisticated models, we always find the same thing – tax policy is the main determinant of the long-run distribution of wealth and income. Progressive income tax and capital taxes are an essential component in the feedback loop, restoring stability on the road towards that best of all possible worlds, that the happy place we call equilibrium.

The debilitating and destabilising effects of rising inequality present a pressing failing of laissez-faire equilibrium thinking. As one of Brave New Europe’s contributors Wolfgang Streeck has written: capitalism is a collective distributional struggle. Although we are talking more about inequality and the 1%, are we talking enough about what the desired distribution should look like? The 1% are uncomfortable with such talk but they do not have the monopoly on power. The people of Europe should demand that their elected representatives swallow the poison and tell us, what is the desired distribution of wealth and income, and how are we going to get there?

 

Comments

  1. Sean Danaher -

    Hi Charles
    thanks. As I have said before I had the joy of living in the US in the late ’70s. I think the US and UK graphs are very similar. I am not using “joy” ironically – things were far from perfect but it was a great country and deserved its “greatest country in the world” description. The rot in the US set in under Regan, as you say very much tax policy and things could get a lot worse under Trump. I am horrified by the current US trajectory.

    In the UK of course we have had Thatcher and in recent years “austerity” and Brexit so the future is very uncertain, but I don’t have a good feeling. Indeed it feels that the it would normally take loosing a major war to pit the UK in such a weak condition.

    I would agree absolutely that inequality at the current level is undesirable and unsustainable and there are two ways of doing this. I have only had a brief look at the figures but some countries do well before taxes and transfers, which in Europe tend to be the Scandinavian ones. Others such as Ireland do well after taxes and transfers. Indeed there was an interesting discussion earlier this week on the http://www.progressivepulse.org/brexit/irish-mist-more-opaque-than-ever/ article. I think its a glass half empty and full thing. One can praise the Irish Government for their very progressive taxation and redistribution policy. One can damn the Irish government for presiding over an economy where redistribution on such a scale is necessary.

    I think however that where taxation and redistribution is essential, it is worth also looking at the structure of a society where CEOs pay can be hundreds of times the average worker in a company. I remember a time when 6-10x was considered excessive.

    1. Charles Adams -

      Thanks. High CEO pay is rent extraction that does not increase efficiency or productivity. It is an example of market failure, arising from the inefficient distribution of market power, closed power networks and an engineered scarcity of skills. An efficient market would produce many CEOs and drive CEO pay down.

      Tax is a useful means to ensure that such inefficiencies and distributional instabilities do not build up, also improving education and developing productive high level skills. The 70s solution for too high pay was income tax rates of 90%. There is a lot of work on optimal tax theory which says that taxes should rise to at least 70% for incomes above around 250k in order to stabilise the distribution and optimise growth. Unless we get this balance right the situation for most people in the UK will get worse. The question I would like to see politicians engage with is what percentage share of total income and wealth should go to the top 1%? And why not spend the market rate (private education rate) on education everyone?

      If their response is that we should leave it to the market, they need to go and read Piketty and Wolfgang Steeck’s Buying time. History tells us that market rules do not lead us towards utopia. To not act before it is too late will bring down the elite too.

      1. Mark Wadsworth -

        “Thanks. High CEO pay is rent extraction that does not increase efficiency or productivity.”

        Amen to that.

    2. MarkB -

      Thatcher? Thatcher saved Britain from the death-grip of labour economic perversion. If you want to imagine a Britain today without Maggie yesterday, think of coal mines still open, but miners still on strike. Thank God for her wisdom and her spirit.

      1. Peter May -

        Well from the death-grip of Labour economic perversion with the miners still on strike I fear climate change would have overcome them.
        And now we are surely in the grip of Conservative economic perversion?
        Certainly an economic decline with the majority earning less since 2010.

      2. Sean Danaher -

        I think we will have to disagree regarding Thatcher. I was in South Yorkshire during the Miners strike and there seemed to be a vindictive delight in crushing them. I suspect the mines would have gone within a decade anyway. It was the naive belief that the market would work in the North of England. The UK as a whole has grown at a modest rate since Thatcher, but the North of England sadly has fallen very far behind.

      3. Charles Adams -

        Indeed, the tragedy was the great pools of talented skilled labour cast onto the scrap heap leaving whole communities to wither. A visionary leader would have put these skills to work and set us on the road to energy independence.

      4. Sean Danaher -

        Particularly as she was an Industrial Chemist by training and unusually for someone on the right had an appreciation of the importance of Climate Change and set up the CRU http://www.cru.uea.ac.uk/

  2. Pingback: Progressive taxation is key to tackling inequality
  3. Andrew (Andy) Crow -

    It’s come to a pretty pass when the notion that income distribution not being self correcting has to be explained as if it were some new revelation.

    But I guess somebody has to keep saying it, so thankyou Charles Adams. And I like the graphics. As well as being charming they also well serve to illustrate the gist of the article. (A picture worth a thousand words and all that)

    1. Charles Adams -

      Thanks, I agree ‘not new’ but whereas in science and engineering if something is unstable we ask how can we stabilise it, in economics, apart from Piketty and a few others, I do not hear the question being asked. In particular, politicians are not asking or addressing this question, so yes it needs to be asked by many people in many ways. As for pictures, credit goes to my collaborator – cohenbaum – as Florence Nightingale showed if people are not listening to the words then may be images will help.

  4. Tyler -

    “The debilitating and destabilising effects of rising inequality”

    Do you have any evidence for this rising inequality? I only ask because the Gini coefficient in the UK has been pretty static since the early 80’s, and has FALLEN since the financial crisis.

    https://www.equalitytrust.org.uk/how-has-inequality-changed

    Also, you have look solely at income. Firstly, the data is pre-tax and pre-social payments, so won’t show the effects of redistribution. So won’t show you the effects of what is already a very re- distributive, progressive tax system.

    Second, if you look at personal wealth (which you can also see on the WiD database) – which is probably a more realistic view of general “wealth” inequality, you can see a very different story – with their share falling for the vast majority of the period, and only stabilising more recently.

    It does make me think you are rather trying to cherry pick your data to fit your political viewpoints.

    1. Charles Adams -

      The Gini coefficient can be very misleading. If you add low paid workers and increase the pay of the boss, Gini falls. The Gini falls while the wage gap and hence inequality is rising – it’s in the maths!

      2007-08 was a crisis which partially restored balance but we did not correct the fundamentals and began heading towards increasing instability again.

      My main point is about stability – if you know that you are following an unstable path, would you continue or do something different? I think this is an interesting question whatever your political viewpoint or wherever you are in the wealth distribution.

      1. Tyler -

        Whilst I agree the Gini can be misleading you haven’t really answered the underlying point.

        Your top 1% data is of pre-tax income, and is presented alone. It is also without the comparator of any lower income groups, so cannot in isolation show that things have become more unequal.

        If you showed post tax, post welfare redistribution trends between different groups, you might have a point. But you don’t. So how are you drawing the conclusion that things have become more unequal?

        Likewise, if you look at the total wealth trends, it shows the top 1% owning less and less of the total – which would suggest that other, lower groups are now owners of more. Again, in isolation it isn’t conclusive but it provides evidence counter to you claim that things have become more unequal.

        As for stability, you have simply made an assertion here. Are we really on an unsustainable path? Your claim, which is not evidence based, looks to me like it is merely an assertion based on your political viewpoint.

        What we do know, from the data, is that *everyone* has got richer over the course of time. Is this unsustainable?

      2. Charles Adams -

        Actually, we know the median income in UK and US is not rising currently – growth and median income have decoupled and a larger share of national income is going to capital.

        But anyway, my question is what is the equilibrium wealth and income share of the top 1% and can we get there without a political or economic crisis? 2008 was a crisis. Some might say the US is in crisis and that Brexit is a crisis.

        I agree with you that the suggestion of what is a crisis and whether they are undesirable is political. I am happy to leave it to the demos to decide!

  5. Tyler -

    “median income in UK and US is not rising”

    I’m sorry but this is simply not true. There was a dip post 2008 but the UK median income has been rising steadily since the early 1900’s. Post 2008 it started rising again after a short hiatus.

    https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/bulletins/householddisposableincomeandinequality/financialyearending2016

    “But anyway, my question is what is the equilibrium wealth and income share of the top 1% and can we get there without a political or economic crisis?”

    That wasn’t your question though, and if it was you have already answered it by saying that things have become more unequal (they haven’t). The wealth share of the top 1% has declined and the income share of the top 1% has increased, but importantly that is BEFORE the effects of taxation.

    But don’t take my word for it – look at the ONS

    https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/bulletins/theeffectsoftaxesandbenefitsonhouseholdincome/2013-07-10

    Once you take taxes and benefits into account, they aren’t seeing the rich getting richer any faster than the poor. So your point?

    1. Charles Adams -

      OK using your data source, and quoting the ONS:

      The average disposable income for the richest fifth of households in 2011/12 was almost two and a half (2.49) times higher than in 1977, once inflation and household composition were accounted for. The average income of the poorest fifth of households has also grown over this time, but the rate of growth has been slower (1.93 times higher in 2011/12 than 1977).

      Same conclusion, inequality has been rising since the ’70s.

      1. Allen Bell -

        That last quote contradicts your earlier claim that median income in the UK has not been rising. And the ONS quote is clear that it is not necessarily the same 1/5th of households that is doing well as it is not based on following cohorts.
        Still , I’m glad that you’ve been reading a little on optimal taxation theory. Taxes on capital are bad, on transactions very bad, on unimproved land value very good, on externalities very good, and on consumption good. Inheritance and income taxes are somewhere in the middle, but should be progressive.

      2. Peter May -

        Lots of off the wall value judgements there… Good or bad for whom and what exactly?

      3. Graham -

        As Peter. VAT, a tax on consumption, is one of the most, perhaps the most, regressive tax and hits the poorest hardest. Capital & transaction taxes will hit the richest – wonder if that’s why you think they’re bad/very bad.

        Re whether inequality is rising/falling/stagnating – we can argue about this until the trillions in tax havens comes home. The important question is whether it’s equitable – it’s not, so what do we do about it?

      4. Tyler -

        That is purely looking at disposable income – not a measure of inequality.

        Again, it looks to me that you already have the narrative you want to portray, and evidence is really only secondary to the political point you are trying to make.

  6. Graham -

    According to Tyler all’s well with the UK, inequality in wealth and income is relatively stable so what’s the problem? The IFS, not noted for its Marxist tendencies, says that “9 per cent of households have no positive net wealth” and “The wealthiest 1% of households hold about 20% of household wealth, the top 5% of hold approximately 40%, and the top 10% hold over 50% of wealth” (https://www.ifs.org.uk/publications/8239) And it is likely that a lot of wealth at the top is hidden. That looks like a “poisonous tendency” to me, even if the inequality in income isn’t quite so extreme.

    If some, perhaps many, citizens and politicians are happy about that I’m not. I believe in equality and as far as income and wealth is concerned I can see no reason, other than greed and malignant power, as to why some should be able to capture such huge slices of the cake while others don’t even get the crumbs, and would like to see limits put on income – say, maximum of 4 or 5 times lowest paid in an organisation – and a similarly low multiple on wealth.

    Unfortunately we live in a corporatist state where the political class have been captured by the rich and owe to them their position on the greasy pole of political power and until the people assert their sovereignty nothing much will change.

    Indeed, Walter Scheidel argues in his book “The Great Leveller” that “only violence and catastrophes have consistently reduced inequality throughout world history” – not an optimistic conclusion.

    1. Peter May -

      Agree – particularly about the lack of wealth that is a feature for so many. A capitalist system where 9% of its members have no capital is, one might surmise, not working.
      Incidentally there are those who point out that even Germany shows high figures for minimal net wealth. This is greatly influenced by the fact that home rental is so widespread. However not for them hiring a man and van every six months and having to find an upfront deposit for a new home, which makes lives so precarious. In Germany tenancies are by default of unlimited duration.

    2. Tyler -

      It shouldn’t be surprising that some households have no net wealth. If you look further into the data, they tend to be young people who simply haven’t had time to accumulate it. Likewise, buy a house and you initially have a negative net wealth as you have a mortgage to pay, with interest against the house.

      1. Marco Fante -

        Tyler,

        Your cleverly selective median income stats forget to mention a lot of things – like this:

        “Median price paid for a home leapt 259% between 1997 and 2016 while earnings rose only 68%, say ONS affordability data”
        https://www.theguardian.com/money/2017/mar/17/average-house-price-times-annual-salary-official-figures-ons

        That’s comes from ONS data as well and its just one of the well-known changes that reflect rising inequality on a class AND generational basis.

        And, before making anymore presumptuous pronouncements about evidence being secondary to political points, you might also want to have a look at this interesting piece from those radical lefties over there at the Financial Times

        “How UK incomes are becoming more unequal — in six charts
        Pay squeeze, tax and benefit changes and housing costs will hit living standards”
        https://www.ft.com/content/fc4a3980-e86f-11e6-967b-c88452263daf

        then reflect on that before you drop in here with a few simple tricks and try to tell us that black is white.

  7. Peter Smaill -

    Wealth data consistently underestimate the assets and post tax benefit- enhanced income of lower quartile groups. In my area we build social housing on a large scale, for £150,000 a house but once the subsidised rental agreement is signed the asset is worth £50,000 under fair value accounting. This effect is not captured in wealth data but it is a property right like any other. The £100,000 loss has not disappeared but now belongs to the supposedly poor tenant ( and heirs).
    Upper quartile pay for property maintenance but social tenants do not. As the IEA has pointed out for decades the statistical basis of egalitarian economics is shot with error and inconsistency.

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