21st Century Capitalism, Inequality, and and the Policy Toolkit

Capitalism qua capitalism is a topic of serious discussion for the first time in the U.S. in a very long time, at least among the NY Times/Atlantic/New Yorker reading demographic. It has been spurred by post-2008 real world conditions and channeled through Thomas Piketty's new book Capital in the Twenty-First Century. A surprisingly weighty tome to top the Amazon non-fiction list, Piketty's book marshals a massive amount of data to show the recent rise in inequality to new gilded age heights. In itself that is not a revelation, but Piketty observes that it is not driven by high incomes (the executive salaries that routinely make headlines) but rather by returns on capital.  He illustrates the growth of the economy versus returns on capital (figure taken from Kruger review of Piketty):


The first amazing fact captured in this diagram is the dramatic drop in the rate of return from capital during the 19th century--the shift away from feudalistic rent-taking to competitive capitalist production. And now the troublesome divergence that emerged in the 1990s and 2000s.

There is good evidence to suggest that a certain degree of inequality is correlated with economic growth.  Too much inequality, however, disarticulates the production and consumption sides of the economy, constricts the opportunities open to the majority of people, a poses serious ethical dilemmas over what is acceptable. Where to draw the line is a technical and moral question, one that we tend to avoid.

Still, there is hope and even some practical solutions. Piketty calls for a 15% tax on capital and an 80% tax on incomes over $500,000.

Piketty's work reminds me of Jon Shayne's interview of Andrew Smithers (previously blogged here) in which Smithers shows the divergence of earning shares going to labor and going to profit:

Smithers argues that executive compensation has introduced a number of incentives that encourage managers to maximize short term profits at the expense of long-term investment in labor and productivity. This is troubling, and unhealthy for the economy in the long haul, as future collective prosperity is foregone for immediate rewards.

In terms of speculation that produces little social benefit, Jon points out that one alternative would be for the capital gains tax rate to become progressively lower over time (i.e. rewarding holding and long-term investment). Economist Bob Frank promotes a steeply progressive consumption tax that would discourage the arms race of conspicuous consumption of positional goods.

From nudges to smart regulation, there now exists a policy toolkit to fix our economic, political, and social woes. If only we would use it.

Economic Lessons from Abroad: Workers, Wages, and Inequality

There are many varieties of capitalism, and, given our current travails, we in the U.S. are starting to realize that we may have a lot to learn from other ways of organizing the economy. 

By law, half of the board of directors at German companies are elected by the workers through a system of "works councils." This is a remarkable fact, and introduces all sorts of different incentives into corporate strategy (as compared to a narrow focus on shareholder value).

Adam Davidson, writing in the NY Times Magazine this week, notes the "beneficial constraints" the German system of worker/capital "co-determination" has on manufacturing there.  Similarly, Davidson shows how Harley Davidson has worked with his highly paid and skilled workers to turn around their failing production. He wonders if this would have been possible without experienced union workers.   

(I write about co-determination in my new book, and have blogged about VW's work's councils and their efforts to institute one at their new Chattanooga facility.)    

And it is not just our other OECD countries that have lessons--and cautionary tales--to offer. Levels of income inequality in the U.S. have over the last decades approached the level of developing countries. The Times today reports that middle class consumption is steadily eroding--from hotels to appliances to restaurants, the high-end and the low-end are growing at the expense of the middle. The Harley workers appear to be the exception. This may result in what Alain de Janvry, writing about developing countries, calls a "disarticulated economy," put simply, one in which workers cannot buy what they make, the opposite of the Fordist promise (to pay workers enough to afford the cars they make).       

Brazil in recent years has made great strides in re-articulating its economy, pulling millions into the middle class and stimulating domestic consumption. Perhaps, then, we should look to Brazil as well as to Germany for economic policy ideas.

Distribution of Value in Anglo-American and German Firms (based on Vitols 2004:371)

	Anglo-American (early 1990s)	Germany (early 1990s)	Germany (late 1990s)
labor	62.2%	85.3%	78.4%
credit	23.5%	5.4%	4.3%
government	14.3%	5.2%	6.8%
retained earnings	3.2%	5.2%	7.8%
dividends	15.0%	2.0%	2.8%

Wellbeing and Wages

Inequality has a huge impact on wellbeing, more so than even absolute income levels. A lot of what we feel about how we are doing, depends on how those around us are doing and our relative standing.
President Obama has been turning attention to inequality lately, and development measures have long taken it into account in terms of general economic wellbeing. And a number of recent studies from psychology, behavioral economics, and management not only help explain this, but point the way toward more optimal solutions:

Mat Richtel reports on recent research that suggests "a deeply rooted instinct to earn more than can possibly be consumed, even when this imbalance makes us unhappy" and that higher income levels may promote "mindless accumulation." In an experimental setting (and uses pieces of Dove chocolate as pay), researchers found that higher earners would work harder to accumulate more chocolate than they would be able to eat (during a limited period after the round of play), while low earners were content to work at a more relaxed pace. The pull of endless accumulation, it seems, can be so powerful as to overwhelm choices that might result in greater overall wellbeing.

Adam Davidson, in his excellent column in the NY Times Magazine argues that "paying [workers] and treating them better, will often yield happier customers, more engaged workers and--surprisingly--larger corporate profits." Citing research by Marshall Fisher (Wharton School) and Zeynep Ton (M.I.T.), he shows that good paying jobs are not only better for workers but also in many ways for the bottom line, to less turnover to more engagement.