For a long time, economists have used production functions to study the impact of changes in the elasticity of substitution between capital and labor in factor income distribution. When the elasticity of substitution is one the relative shares remain constant, when it is greater than one the share of capital increases and when it is less than one the share of labor rises.
Most economists believe that the remarkable stability of the relative share of capital and labor in total income experienced in capitalist countries is due to the fact that technical progress is either neutral (and the elasticity of substitution is one) or is mildly labor-saving but the relative earnings of labor in relation to capital will decline due to a relative labor abundance, thus moving the elasticity close to one. But, what will happen to capitalism if technical progress turns extremely labor-saving and labor income becomes negligible or negative?
For instance, imagine a futuristic scenario where each one of us owns personal robots better than us in all domestic and professional tasks, not just the simply tasks of cleaning and similar. Science fiction typically depicts such scenario in terms of who will be the master, us or the robot, but I will assume that humans will be the masters.
Following the law of comparative advantage we would leave to the robots the tasks where they had a comparative advantage, for both pleasant and unpleasant jobs. However, by increasing the number of robots relative to that of humans, humans would be able to skip entirely all the unpleasant tasks. Therefore, the few pleasant jobs left to humans would be mostly the design and supervision of robots and to decide on collective investments. Because these function will not occupy many people jobs for humans will be so scarce that workers might be willing to pay for the privilege to work rather than be paid.
So, in such a world, how would capital accumulation and economic exchange work? Could the six principles of capitalism survive in such world? Can we imagine exchanges to continue as usual but now with trading between robots at a speed not accessible to humans?
In such a world the accumulation of human capital (skills and education) will be driven by non-economic factors and everyone’s income is essentially determined by capital returns. Thus everyone would need to own traditional assets and robots either directly or indirectly through collective investment vehicles (e.g. pension funds) or the government.
That is, the markets for goods and services could work as they do now but the labor market would be substantially different, since humans would no longer be sellers but buyers in such market. Likewise, preferences for consumption and accumulation will be altered since in such society the leisure class will be a majority while the working class is a small minority.
There would be then three types of assets, the traditional forms of property, the human replicas (slave robots) and the embodied skills and human capital necessary to qualify to buy the right to work. The first two types of capital can be merged in two categories - traditional assets and slave robots. Therefore, one could still use the conventional two-factor model so that in a product function we were left with two single inputs, traditional capital and slave robot labor, and again define an elasticity of substitution between them in the usual way.
The only requirement is that slave robots be separable from their owners so that they may be traded like any other type of capital. In this futuristic world, private property would still be needed to drive consumption and capital accumulation, but human labor supply would no longer constrain the rate of capital accumulation and could be considered as perfectly elastic. Therefore, the personal fortune of each individual robot-owner will depend entirely on its initial endowment, investment skills and luck on selecting their portfolio of capital and robots.
The jobs for humans would be a status symbol to be achieved through other means rather than competitive markets, namely through hereditary rules, lottery or voting. All job positions could be theoretically auctioned, like old master paintings, but it would be inefficient. Such a society would resemble Ancient Rome but with robots instead of human slaves.
Nevertheless, it is unlikely that self-reproducing slave-robots could be left entirely in the hands of private individuals. Even assuming a good regulatory environment, most people might prefer state ownership fearing that robots might turn against humans.
If that happens one could no longer rely on comparative advantage, even in the context of a single factor (slave-robots) model, because that factor would be jointly owned (state owned). Moreover, slave-robots would be more homogeneous than humans which would make them less differentiated in terms of comparative advantage. So, new solutions will have to be found.
In conclusion, the ways humans chose to regulate the production of humanoid slave-robots will determine how a new economic system may differ from capitalism.
Showing posts with label income distribution. Show all posts
Showing posts with label income distribution. Show all posts
Tuesday, 22 December 2015
Tuesday, 28 July 2015
Production, income and welfare under capitalism
When we take a detached long term look at human history, it is impossible not to be impressed by the global economic growth experienced since the rise of capitalism in the early XIX century. This was achieved despite two destructive world wars and the subjugation of half of the world population under communism throughout most of the 20th century.
In his history of economic growth Angus Maddison (2005) shows that: “Over the past millennium, world population rose 23-fold, per capita income 14-fold, and GDP more than 300-fold. This contrasts sharply with the preceding millennium, when world population grew by only a sixth, with no advance in per-capita income”.
Yet, during the first eight centuries of the last millennium economic growth barely matched population growth, while life expectancy only rose from 24 to 36 years. However, from 1820 onwards, per-capita income rose twenty-four times as fast as in 1000–1820, population grew six times as fast and life expectancy increased to seventy-nine years in the West and sixty-four in the rest of the world.
Nevertheless, this was not an even process and it is interesting to recall the various phases identified by Maddison as:
1. The “golden age,” 1950–73, when world per capita income grew nearly 3 percent a year, by far the best performance.
2. Our age, from 1973 onwards (henceforth characterized as the neo-liberal order), is the second best.
3. The old “liberal order” (1870–1913) was third best, only marginally slower in terms of per capita income growth.
4. In 1913–50, growth was well below potential because of two world wars and the intervening collapse of world trade, capital markets, and migration.
5. The slowest growth was registered in the initial phase of capitalist development (1820–70), when significant growth momentum was largely confined to European countries, Western offshoots, and Latin America.
This historically unprecedented growth, the result of a combination of science and capitalism, was more pronounced in the West during the post-world war II period. However, since the collapse of communism we have more examples to show the power of capitalism as a production machine. In particular, when we compare the recent experiences of China, Russia and India, we note that Russia and India are lagging significantly largely because they have been more reluctant to endorse capitalism.
Nevertheless, the fact that large populations still live in poverty raises the question of whether they have been left behind by capitalism. This is not a failure of capitalism. On the contrary, it was often the result of misguided pursuits of alternative systems and the slow take-off under capitalism. Indeed, given the recent moves in Africa towards capitalism, one expects that this continent will progressively begin to recover and will accelerate its growth in the next decades.
Likewise, for those who expected the liberation of half the humankind from communism and the recent surge in technological developments to automatically create another era of unprecedented growth, the early history of capitalism from 1820 to 1870 is an important reminder that take-off is usually a slow process.
The transition to capitalism from subsistence, feudal or communist economic systems faces many resistances and the economic cycles of capitalism may slow down such transition. Both need to be assessed separately, as well as the risks of political turmoil. Otherwise, we risk letting such setbacks obscure the remarkable efficiency of capitalism to eradicate poverty and promote economic growth.
In his history of economic growth Angus Maddison (2005) shows that: “Over the past millennium, world population rose 23-fold, per capita income 14-fold, and GDP more than 300-fold. This contrasts sharply with the preceding millennium, when world population grew by only a sixth, with no advance in per-capita income”.
Yet, during the first eight centuries of the last millennium economic growth barely matched population growth, while life expectancy only rose from 24 to 36 years. However, from 1820 onwards, per-capita income rose twenty-four times as fast as in 1000–1820, population grew six times as fast and life expectancy increased to seventy-nine years in the West and sixty-four in the rest of the world.
Nevertheless, this was not an even process and it is interesting to recall the various phases identified by Maddison as:
1. The “golden age,” 1950–73, when world per capita income grew nearly 3 percent a year, by far the best performance.
2. Our age, from 1973 onwards (henceforth characterized as the neo-liberal order), is the second best.
3. The old “liberal order” (1870–1913) was third best, only marginally slower in terms of per capita income growth.
4. In 1913–50, growth was well below potential because of two world wars and the intervening collapse of world trade, capital markets, and migration.
5. The slowest growth was registered in the initial phase of capitalist development (1820–70), when significant growth momentum was largely confined to European countries, Western offshoots, and Latin America.
This historically unprecedented growth, the result of a combination of science and capitalism, was more pronounced in the West during the post-world war II period. However, since the collapse of communism we have more examples to show the power of capitalism as a production machine. In particular, when we compare the recent experiences of China, Russia and India, we note that Russia and India are lagging significantly largely because they have been more reluctant to endorse capitalism.
Nevertheless, the fact that large populations still live in poverty raises the question of whether they have been left behind by capitalism. This is not a failure of capitalism. On the contrary, it was often the result of misguided pursuits of alternative systems and the slow take-off under capitalism. Indeed, given the recent moves in Africa towards capitalism, one expects that this continent will progressively begin to recover and will accelerate its growth in the next decades.
Likewise, for those who expected the liberation of half the humankind from communism and the recent surge in technological developments to automatically create another era of unprecedented growth, the early history of capitalism from 1820 to 1870 is an important reminder that take-off is usually a slow process.
The transition to capitalism from subsistence, feudal or communist economic systems faces many resistances and the economic cycles of capitalism may slow down such transition. Both need to be assessed separately, as well as the risks of political turmoil. Otherwise, we risk letting such setbacks obscure the remarkable efficiency of capitalism to eradicate poverty and promote economic growth.
Sunday, 16 January 2011
Nature vs. Nurture and Equal Opportunity
Mankiw has an interesting post in his blog where he says that: “In light of the heritability of talent, it would be shocking if we did not find some significant heritability of income”. This is logical, but it ignores other important determinants of the nature vs. nurture debate, most importantly the opposite effects of nepotism and indolence. While rich kids benefit from nepotism they are also victims of laziness. The better policy to eliminate the bias introduced by these two factors is to increase the share of market capitalism in the economy. In end, the rise of government and managerial capitalism benefits more the incumbents than the newcomers.
His other point that “moving up and down a short ladder is a lot easier than moving up and down a tall one” is a fallacy. Economic mobility must be measured between all steps of the ladder, not just between the first and last steps (that is why economists prefer the Atkinson measure of inequality). We (I) may wish to claim that a more egalitarian society creates greater economic mobility. However, this only applies in relation to share of capital of the super-rich. If for tax reasons, like in the USA, it rises disproportionally they will obviously capture a top-heavy share of investment opportunities.
Arguments based on the observation that countries with the greatest income inequality (USA and UK) are the ones with lesser intergenerational mobility are not solid. For instance Canada and Sweden, two of the countries with greater mobility (see data here), have substantially different levels of income inequality (find data here).
His other point that “moving up and down a short ladder is a lot easier than moving up and down a tall one” is a fallacy. Economic mobility must be measured between all steps of the ladder, not just between the first and last steps (that is why economists prefer the Atkinson measure of inequality). We (I) may wish to claim that a more egalitarian society creates greater economic mobility. However, this only applies in relation to share of capital of the super-rich. If for tax reasons, like in the USA, it rises disproportionally they will obviously capture a top-heavy share of investment opportunities.
Arguments based on the observation that countries with the greatest income inequality (USA and UK) are the ones with lesser intergenerational mobility are not solid. For instance Canada and Sweden, two of the countries with greater mobility (see data here), have substantially different levels of income inequality (find data here).
Wednesday, 14 July 2010
Is Keynes wrong or outdated on “the euthanasia of the rentier”?
Writing during the depression of the 1930s, Keynes feared that the return to full employment might require a protracted period of low interest rates which could bring about the euthanasia of the rentier classes. In his words: “Now, though this state of affairs (…to increase the stock of capital up to a point where its marginal efficiency had fallen to a very low figure…) would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital”. J. M. Keynes, General Theory, pp. 375-76.
Keynes was writing his General Theory during a strong bull market in bonds, following the 35% collapse of high grade USA corporate bond yields to below 3.5% from a peak of 5.41% in June 1932. The bull market in bonds would continue for another 10 years, until April 1946, when yields bottomed at 2.46%. Likewise we have lived through a 28-year long bull market in high yield corporate bonds and have gone through a severe recession and financial crisis. The current bull market in bonds and the economic recession are milder than in the 1930s, with a decline of only 15% in corporate yields from 5.79% in June 2007 to 4.88% in June 2010. Yet, in historical terms, these are the closest we have to the 1930s. Like Keynes we do not know if the current bull market will continue for another 10 years. So, it is pertinent to consider whether Keynes predicament in relation to the euthanasia of capitalists is still valid today.
With the benefit of history we now know that his fears were unwarranted. Indeed, the next bear market in bonds, which would last until 1981, ran throughout the years of the fastest economic growth known to humanity (the golden fifties and sixties). Similarly, after the current 28-year bull market in bonds that began in 1982, we now know that the wealthy are well and getting richer. In fact, they have probably just gone through the period of greatest wealth concentration ever experienced in the USA and many other countries. Last April, the Congressional Budget Office in the USA published data showing that the real after-tax average income of the Top 1 percent income group had almost quadrupled between 1979 and 2007 while the income of those in the bottom 3 quintiles (the lowest 60%) barely moved during the past 29 years.
To be fair, with the possible exception of Japan, no country has ever come near to the almost 0% yield envisaged by Keynes. Nevertheless, there is no doubt that his predicament is outdated and wrong. Yet, because of the risk that an excessive concentration of wealth represents for the future of capitalism, we need to delve further on the reasons why he got it wrong. In our view, the two main reasons were his excessive reliance on the role of interest rates as a determinant of the level of investment required by full employment and his outdated view on how the rich got richer.
Beginning with the way the rich get richer, there are nowadays three important sources of wealth that were disregarded by Keynes. First, there is a new breed of millionaires that make their fortune as corporate raiders. These include private equity and hedge fund managers, investment bankers, CEOs and Non-executive Directors involved in corporate acquisitions and restructurings. To illustrate this new reality one has only to look at the ten-fold increase in their compensation packages, from a ratio of 20:1 during the Robber Baron’s years of the early 20th century to the current 200:1 ratio. Some anecdotal evidence reported by Robert Frank in his book Richistan: a Journey Through the American Wealth Boom and the Lives of the New Rich even shows that some millionaires now make more money from Non-executive directorships than from the returns on their wealth. Second, many of the wealthy have now a large percentage of their portfolio invested in equity, real estate, commodities and alternative investments which are not always correlated with fixed-income and which had a tremendous run in the past 30 years. This greater reliance on capital appreciation rather than on capital growth decouples a large share of their wealth growth from interest rates. Finally, the growth in offshore investment and a cap in progressive income taxation with the top rates generally below the share of public spending in the economy (or even declining as in the USA) have benefited the wealthy.
Turning now to the role of interest rates as determinants of the level of investment, we can see that Keynes missed an important determinant of investment – the level of leverage. As we have shown elsewhere, in a credit-based economy like ours, the marginal efficiency of capital is shifted by leverage making its influence on the level of investment equally or even more important than the level of interest rates. So those able to use higher levels of leverage (like the financiers) are in a better position to accumulate a disproportionate share of income and wealth, in particular when governments underwrite their excessive risk-taking through bail-outs.
We conclude, by paraphrasing Mark Twain, and state that “the announcement of the rentiers’ death was premature”. And complete it by adding our own pronouncement that to secure a vibrant market capitalism we must tackle the problems caused by the new sources of wealth accumulation and financial leverage.
Keynes was writing his General Theory during a strong bull market in bonds, following the 35% collapse of high grade USA corporate bond yields to below 3.5% from a peak of 5.41% in June 1932. The bull market in bonds would continue for another 10 years, until April 1946, when yields bottomed at 2.46%. Likewise we have lived through a 28-year long bull market in high yield corporate bonds and have gone through a severe recession and financial crisis. The current bull market in bonds and the economic recession are milder than in the 1930s, with a decline of only 15% in corporate yields from 5.79% in June 2007 to 4.88% in June 2010. Yet, in historical terms, these are the closest we have to the 1930s. Like Keynes we do not know if the current bull market will continue for another 10 years. So, it is pertinent to consider whether Keynes predicament in relation to the euthanasia of capitalists is still valid today.
With the benefit of history we now know that his fears were unwarranted. Indeed, the next bear market in bonds, which would last until 1981, ran throughout the years of the fastest economic growth known to humanity (the golden fifties and sixties). Similarly, after the current 28-year bull market in bonds that began in 1982, we now know that the wealthy are well and getting richer. In fact, they have probably just gone through the period of greatest wealth concentration ever experienced in the USA and many other countries. Last April, the Congressional Budget Office in the USA published data showing that the real after-tax average income of the Top 1 percent income group had almost quadrupled between 1979 and 2007 while the income of those in the bottom 3 quintiles (the lowest 60%) barely moved during the past 29 years.
To be fair, with the possible exception of Japan, no country has ever come near to the almost 0% yield envisaged by Keynes. Nevertheless, there is no doubt that his predicament is outdated and wrong. Yet, because of the risk that an excessive concentration of wealth represents for the future of capitalism, we need to delve further on the reasons why he got it wrong. In our view, the two main reasons were his excessive reliance on the role of interest rates as a determinant of the level of investment required by full employment and his outdated view on how the rich got richer.
Beginning with the way the rich get richer, there are nowadays three important sources of wealth that were disregarded by Keynes. First, there is a new breed of millionaires that make their fortune as corporate raiders. These include private equity and hedge fund managers, investment bankers, CEOs and Non-executive Directors involved in corporate acquisitions and restructurings. To illustrate this new reality one has only to look at the ten-fold increase in their compensation packages, from a ratio of 20:1 during the Robber Baron’s years of the early 20th century to the current 200:1 ratio. Some anecdotal evidence reported by Robert Frank in his book Richistan: a Journey Through the American Wealth Boom and the Lives of the New Rich even shows that some millionaires now make more money from Non-executive directorships than from the returns on their wealth. Second, many of the wealthy have now a large percentage of their portfolio invested in equity, real estate, commodities and alternative investments which are not always correlated with fixed-income and which had a tremendous run in the past 30 years. This greater reliance on capital appreciation rather than on capital growth decouples a large share of their wealth growth from interest rates. Finally, the growth in offshore investment and a cap in progressive income taxation with the top rates generally below the share of public spending in the economy (or even declining as in the USA) have benefited the wealthy.
Turning now to the role of interest rates as determinants of the level of investment, we can see that Keynes missed an important determinant of investment – the level of leverage. As we have shown elsewhere, in a credit-based economy like ours, the marginal efficiency of capital is shifted by leverage making its influence on the level of investment equally or even more important than the level of interest rates. So those able to use higher levels of leverage (like the financiers) are in a better position to accumulate a disproportionate share of income and wealth, in particular when governments underwrite their excessive risk-taking through bail-outs.
We conclude, by paraphrasing Mark Twain, and state that “the announcement of the rentiers’ death was premature”. And complete it by adding our own pronouncement that to secure a vibrant market capitalism we must tackle the problems caused by the new sources of wealth accumulation and financial leverage.
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