Inequality in the US

That inequality has been growing in India and Brazil is well known. I have been writing about it for some time now (“Income distribution: Recent developments”, Business Standard, October 16, 2018). What is more striking perhaps is how inequality has grown in the United States. A recent issue of The Economist appeared to minimise the concern on its cover, with, “Inequality illusions: Why wealth and income gaps are not what they appear”. That has pushed me to react, for it may be sensational but circumvents reality. It reported on recent scholarly papers that appear to contradict the findings of earlier papers about rapidly worsening wealth and income gaps in the US. A careful perusal of The Economist’s coverage reveals that the new papers do not reverse the findings of the earlier papers. They tone down the extent somewhat. Thus, the conclusion that inequality has increased significantly since the 1980s remains intact. The new findings use new data in an intelligent way; therefore their inability to reverse the earlier conclusions actually supports the robustness of the initial findings.


For a comprehensive assessment, how markets function should be the beginning. Adam Smith’s Wealth of Nations, published in 1776, is its foundation. In it, individuals are driven by personal gains. Their “animal spirits” yield the maximum goods in the market for consumers to enjoy at the lowest prices. Thus, selfishness maximises social welfare. Underlying this principle is pure competition among suppliers.


Subsequently, economists modified that model when there are few suppliers who could control market prices. Then, market prices would not be competitive and consumers would have to pay higher prices. Nevertheless, the invisible hand principle was found to be reliable in explaining the primary motivation behind market functioning.

illustration: Binay Sinha
Further, as efficiency in production processes and labour productivity improved over time, and technology advanced, economic rate of growth that followed would result in a “steady state growth”. Along that path, all resource owners would experience that returns to their capital or labour were moving at the same rate. If this equalled population growth rate, that comprised the “golden rule” for a growing economy.


That rule said nothing about initial endowments of resource owners. This was enunciated in 1896 by Vifredo Pareto, an Italian economist. As an economy chugged along, as long as someone gained without anyone becoming worse off than before, that was “optimal”. As a budding, perhaps a bit rebellious, economist,it bothered me that even if an economy’s initial position had a horrid income distribution, there was no recognition to directly uplift the position of the poor at higher rates than that of the non-poor. So I wrote, “Non-Ethical Distribution and Failure of Markets,” my Masters thesis. I was delighted yet surprised that it was accepted at one go.


All economic theory was based on the efficacy of the perfect market. Accordingly, taxation theory advanced to arrive at conclusions regarding who bears the eventual “incidence” or burden of various taxes. Its results were neat and generalisable beyond the usual two product — two factor model, for any number of products and factors (resources for production). Hence, they were called tax incidence “theorems”. This supplication at the altar of the market continued to bother me. Hence, my PhD thesis demonstrated how the neatness of results for a market economy breaks down relatively easily. All that was needed was to introduce a single distortion, say, a third resource or factor of production such as land (over and above capital and labour) in any one sector of production (say corporate or non-corporate).


These efforts of mine I refer to here since I never danced to the tune that markets worked flawlessly. My findings and results, completed in the early 1970s, however small, could not affect from the sidelines the thinking of the US economics establishment, its confidence in markets was so strong. It was not easy to get top effective attention despite awards or prizes. Perhaps also, within the boundary of its definitions, the market economy performed acceptably until the 1970s for, by and large, economic agents experienced decent investment returns and wage increases, and standards of living did improve. Indeed, economists seemed confident that the “problem of depression prevention has been solved.”


From the 1980s, however, the basic principle —market competition — began to crack, more so in the new millennium. What happened? First, its bulwark had been full information among economic agents and, second, each agent had to be small enough not to be able to affect market prices, leave alone destabilise them.


These two principles began to break down slowly but surely. To begin, information capture grew through the advent of information technology (IT). Analysts used information from secure pooled global data to perceive and project global commodity prices and where they would crest. While uninformed investors sold off with small rises in their stocks and shares —speculation leads to economic stabilisation — informed investors bought even more while prices were rising, thus destabilising prices and “market fundamentals”.


Such operators who successfully captured the “asymmetry of information” using IT, gained in incalculable multiples of their initial investments. After repeatedly destabilising global markets and amassing disproportionate returns, they reappeared as global philanthropists, the first paradox perhaps of the New Millennial Era. More sectors — take the financial sector for example — fell under the same spell.


At the macro level, the capture facilitated the winning agents to extract maximum value from the markets even as markets collapsed in repeated global crises (1997-98, 2007-08, others) around them and trillions of dollars were washed out from stock market value. The winning agents emerged as global giants in diametric contraposition to the quintessential small market operator. The disappearance of the two elements — full information and significance of the small competitor — ushered in the death of the perfectly competitive market. With that, inequality became inevitable.


Apart from macroeconomic factors, the new millennium’s micro-economic indicators reveal how inequality is escalating in the US across incomes, and in gender, race,economic mobility and so on1. This body of literature comprises a paradigm shift in thinking, analysis and contingent policy action to redress and eradicate inequality. It has important lessons for India. I plan to cover this micro data literature in the future.


1. It reflects the emerging work of Thomas Piketty, Emmanuel Saez, Gabriel Zuchman, Raj Chetty, Lena Edlund, Wojciech Kopczuk, and Heather Boushay among others.


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