Notes on the Economic Nature of (In)Equality

Even though structural economic contributions to inequality are far from clear, they ultimately hold more importance than moral rationale, due to how they inevitably impact social outcomes at some point. Increasingly in advanced nations, it is the assets and services which are scarce due to their direct links with time and place, which matter most for how inequality continues to play out for most citizens. We need a better understanding how our non tradable sector expectations and demands - especially when exacerbated well beyond necessity - affect the conditions of general equilibrium.

Nevertheless, much more is still being expressed about the purported morality of wealthy individuals or firms than structural contributions to inequality (and regular readers also know I believe structural matters go well beyond taxation and regulation). Recently, for instance, Greg Mankiw wondered, what if the prototypical rich person is actually moral? Taking an opposite tack, Branko Milanovic (for ProMarket) wrote that "Davos elites love to advocate for equality - so long as nothing gets done."

While it is sometimes understandable to focus on immorality in marketplace activity, we need to understand the long term equilibrium ramifications, when economic activity which is naturally scarce (in terms of time and place) dominates activities which could otherwise contribute to scale and marketplace expansion. In particular, as economic activity which also experiences artificial constraints begins to dominate, it greatly affects general equilibrium outcomes. After a certain point in this process, inequality becomes entrenched in ways which are often difficult to overcome.

Presently, there is little understanding how the natural scarcities of non tradable sectors affect existing inequalities. These sectors are disrupting the circles of sustainability which tradable sector activity has brought to society in recent centuries. Thus far, the natural scarcities of place and time are especially problematic for wide income variance among citizens in advanced nations, where non tradable sector activity has already dominated tradable sector activity for decades - especially since the former offers few viable economic options for low income levels. Worse, the central bank policy response thus far, has been to withhold sufficient monetary representation, given the dominance in advanced nations of activity which does not readily scale.

Fortunately, the positive part of the story is of course that tradable sector growth in emerging nations continues to lessen existing inequalities across the globe. Any time that activity dominates in which ability to scale is a major component, the proceeds are readily spread among more citizens and participants. In particular, the capitalist contribution to inequality is not necessarily as strong as some on the left have imagined. In Why Most Things Fail (2005), Paul Ormerod expressed concern there was no theoretical framework in which inequality could be understood. He consequently questioned the relevance of the general equilibrium theory (pages 50 and 51) and added:

the most relevant feature of general equilibrium theory is that it tells us nothing at all about the degree of inequality in a society.

However, Ormerod also noted that capitalism delivered to a far greater degree than Karl Marx would ever have expected. Re Marx's "iron law of wages" theory:

The theory has been refuted empirically. The share of wages in national income is considerable higher than it was a century ago, and the share of profits smaller. Workers have become better off relative to capitalists. Indeed, we can go even further than that, for most workers have become in part capitalists themselves. Pension schemes, for example, receive much of their income from dividends on equities, which are, of course, paid out of the profits generated by companies.

Again, consider how wage gains accrued over the last century. It is fair to say that in many instances, the majority of tradable sector activity has been a great contributor to equality. As more individuals were brought into traditional manufacture, there were more consumers for output, and output expansion also (gradually) translated into higher wages. Non tradable sector activity lacks opportunities to equalize or redistribute income, in part because of its existing scarcity constraints for both time and place based output. Of course this is a global reality, and a recent sentiment from Edmund Phelps applies to advanced nations in particular:

The West is in crisis - and so is economics. Rates of return on investment are meager.

Despite the fact so many of us have become capitalists - at least to some degree - it turns out that investment for human capital functions radically differently, if and when it directly links to economic processes which don't scale. Output which doesn't scale is even more problematic since much of it has been expected to occur in places where real estate experiences its highest costs. All too often, what investment gains there are in these circumstance, lack many of the positive cumulative effects which tradable sector wealth provides. While we can't negate the importance of product which doesn't scale, we still need to start thinking outside the box, re how to capture and preserve for long term gain, the wealth of human capital.

Alas, we can't fully compensate all who want to provide skills arbitrage on monetary terms, once economies become dominated by non tradable sector activity. But we can think differently, how to achieve defined equilibrium gains when general equilibrium has exhausted its primary means of continued economic expansion. It's important to do so, given the fact inequality increasingly means an inability for many to participate in the present demands which non tradable sectors have imposed on general equilibrium settings.