Economics Can’t Answer Why Inequality (Sometimes) Declines

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In September I went to an international conference in Vienna, Austria, The Haves and the Have Nots: Exploring the Global History of Wealth and Income Inequality, about which I wrote in a previous post. One thing I learned at the conference is that, apparently, economists don’t really know why inequality increases and decreases. Especially, why it decreases.

Let’s start with Thomas Piketty, since Capital in the Twenty First Century is currently the “bible” (or should I say “Das Kapital”?) of inequality scholars.

pikettydaskapital

Piketty provides a good explanation of why inequality increases. It’s good not in the sense that everybody agrees with it, but in the sense of being good science: a general mechanism that is supported by mathematics and by data.

So far so good. But how does Piketty explain the decline of inequality during the middle of the twentieth century? It was a result of unique circumstances—two destructive world wars and the Great Depression. In other words, and forgive me for crudeness, shit happens.

This is not a particularly satisfactory conclusion. Of course, it’s possible that the general trend of inequality is always up, except for random exogenous events that knock it down once in a while. So devastating wars destroy property, and by making the wealthy poorer reduce inequality. This is one of the inequality-reducing forces that Piketty mentions several times in his book.

To me such exogenous explanations are not satisfactory. My intuition (which I understand may not be shared by all) is that when inequality gets too high, there are forces that bring it down. In other words, to some degree it’s a regulatory process, and that’s why we don’t see truly extreme forms of inequality (when one person owns everything). In Piketty’s view, the only reason we don’t see such extremes is because some kind of random event always intervenes before we get to it.

In his talk Branko Milanovic addressed the question of what brings down inequality. As he must – if inequality indeed moves in cycles, as he proposed, then there has to be some endogenous process that is triggered when inequality gets too high, and brings it down. Periodic operation of such a mechanism is what would generate repeated cycles.

Branko admitted that “malign” forces that could bring down inequality are not well-studied. As to “benign” ones, he cited three that fall under the acronym TOP: technology, globalization, policy. The only one that makes sense to me is policy—indeed, governments can reduce inequality by taxing high income and wealth. As to the first two, technology and globalization, I think that they rather explain why inequality increases.

In a later talk, Walter Scheidel addressed the “malign” forces. Walter is working on a book with a tentative title The Great Leveler, in which he identified four forces that have reduced inequality in historical societies:

  • Mass mobilization warfare
  • Transformative revolution
  • State collapse
  • Pandemics

 

The Four Horsemen of the Apocalypse 1937 André Fougeron 1913-1998 Purchased 2001 http://www.tate.org.uk/art/work/T07707
The Four Horsemen of the Apocalypse (1937) by André Fougeron (1913-1998) Source

Note that all of them are “malign”, because they all involve violence. So violence is the great leveler. But of course some forms of violence result in increased inequality. Take war. Many conquest wars, for example those in which a band of warriors conquers egalitarian farmers, turns them into serfs, and sets the victors up as the ruling class — such wars obviously result in increased inequality.

This is why Walter focuses on mass-mobilization warfare. Societies that are forced to mobilize all citizens capable of bearing arms (or, at least, all males) are usually—always?—forced to reduce inequality. Same thing with revolutions—not all of them reduce inequality. Some simply exchange one set of oppressive elites for another. But others do level the weath quite dramatically.

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Ivan Vladimirov (1869-1947). Storming the Winter Palace. Source

I think Walter is on to something, and his theory can be made endogenous. That is, when inequality becomes too high, the chance of a state collapse or transformative revolution increases. Alternatively, or additionally, hugely unequal societies are defeated by more equal ones, which either eliminates them, or forces them to reduce inequality to rise up to this existential challenge.

In my view, Walter’s theory captures something important, but it is incomplete in two ways. First, we need a better understanding of why violence in some situations increases inequality and in others decreases it. Second, I think there are mechanisms other than violence that can reduce inequality. However, I am not very sure of this. Perhaps it’s just the optimist in me that wants to believe it.

As a way of concluding, what does it tell us about economics’ capacity to explain the dynamics of inequality? In my opinion, economics is perfectly capable of explaining why inequality increases, but fails to do so for inequality decreases, because they are a result of extra-economic forces. So if we want to understand how historical societies reduced inequality, we need to go beyond economics and bring insights from history, sociology, and anthropology.

And I certainly hope that we can figure out how to reduce inequality without violence.

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Peter Richerson

It seems to me that political struggle can reduce inequality without necessarily [much] violence. Labor agitation in the US from the late 19th century through the 1950s played a large coercive role in reducing inequality. The US elite faced a choice, give labor a fairer share of the economic pie or eventually face revolution. Led by FDR and like minded actors, the political elite pushed the business elite to reduce inequality to avoid revolution. Whether this would have happened without two mass mobilization wars is an open question, but union organizing and the agitation of radical political parties struck fear into the elite, hence the Palmer Raids and Edgar Hoover’s excesses. But those creeps were middle class boys on the make, scaremongering the elites in the pursuit of elite position for themselves. They may have help the egalitarians be exaggerating the power of the “Reds.” A credible threat of revolution can coerce elites pretty effectively.

Even Gandhian non-violence can be very effective. If you can organize a large mass of non-elites fanatically committed to non-violence, the elite has to worry what might happen if the non-violent fanatics suddenly got violently angry. The CP of China seems to really fear apparently harmless mass organizations like Falun Gong. Apolitical mass organizations are a threat to elites if inegalitarian or otherwise unfair treatment of commoners is common. Any such organization can morph into violent resistance at the drop of an atrocity.

OlgaS

Mr Richardson,
may I just support your argument. in course of all the social evolution political structure was developing together with the growing technical power of humanity. If they both evolved in accordance, the very slf-protection mechanism made the state-elite developing political structure as a mechanism to allow some “exchanging drive” in the state achieve its goal without bursting up in revolution.

diligentdave

I remember reading where Piketty pointed out that when population growth rates are higher, like during the so-called ‘baby boom’ (in the US, from about 1946 – 1964, for example), this tends to affect less inequality overall.

I would think that higher human fertility rates, especially in more advanced economies, spur innovation, which in turn changes wealth dynamics. Newer industries (think personal computers, internet, etc) bring more innovation.

Many have noted that most innovation is brought to fruition by those in their 20’s to 40’s. With a lower ratio of those to older people, not due to the so-called ‘baby boom’ as Rand Paul said, in the last Republican Presidential debate, but because the ‘boomers’ themselves failed to have anything but overall a sub-replacement birthrate (below 2.11 children, on average, for every 1 woman per lifetime).

When wealth is passed down from generation to generation in a family, fewer children in wealthy families hoard that wealth, and increase it by purchase (acquisitions). But, when there are a higher proportion of youth, then marketplace dynamics change more; hence, more wealth is created, and ‘new money’ to “up and comers” by itself spreads the wealth by itself.

Currently, most of the world has been in for some decades, and more nations, even developing ones, have been trending to, and many are in or at sub-replacement human fertility rates (which, BTW, is trending towards a situation not seen widely for over 600 years).

Since the Black Death around the middle of the 14th century (mid 1300’s). the world is poised (mid-21st century) to likely begin in big numbers to lose population at an exponential rate as big as worldwide populations increased. Since faster population growth tends to level income and wealth disparity, sub-replacement growth would tend to further skew wealth, as it is hoarded by acquisition (where the “rich get richer” and consequently, the “poor get poorer”).

Ergo, increase at a sustained level population growth, and the problem may begin to take care of itself, through more innovation, and more wealth generation, and wider wealth distribution.

Ross Hartshorn

It seems to me that war needn’t be an exogenous, or coincidental, factor in reducing inequality. I could easily imagine that societies with an entrenched elite that is much, much wealthier than the masses, would be more likely to get into a war. For one thing, they are unlikely to fight in it. For another, they may be more accustomed to getting their own way in the domestic arena, and think they can get their own way without negotiation in foreign disputes as well. Much of the history of WWI which I’m currently relearning as we pass various 100-year anniversaries, seems to point to the fact that the Central Powers were often quite isolated from reality in their decision making. The less unequal societies of France, the U.K., and the U.S.A. made mistakes as well, but not as catastrophic as the Central Powers (and also Russia).

So, still pessimistic, but theoretically more satisfying: war is not a random event which has the effect of reducing inequality, but rather the chance of war goes up the more unequal the society becomes.

Richard

Was Germany pre-WWI more unequal than the (highly unequal) Anglo states of the USA and UK in that period?

Ross Hartshorn

Good point, and on that note, would this sort of hypothesis be testable using the Seshat database, soon? And if so, would it be accessible by anyone other than professional academics? 🙂

Bella McFadgen

No mention of population decline? I quite liked the theory that after the Great Plagues in Europe inequality reduced because there were fewer capable workers and they could command a higher price. Simple supply and demand.

Martha Dunham

I agree with Bella McFadgen. In fact, my theory outlined in Theoretical Population Biology provides a four-dimensional model pertaining to behavioral choices. I believe it provides a possible solution for a lower level of aggressive behavior to result, in part based on population size. You may argue with my assumptions — hopefully there is enough meat to the theory that it provides food for thought. One way of looking at the assumptions in this model is to consider them as variables that have been arbitrarily set constant. Of course, as you add variables, you need more thought-years in order to find a solution.

Juan Alfonso

Hi Peter,

So violence or the fear of violence is what restores equality. I agree. But the question that arises is: where does the drive for violence come from in the first place?… This is what traditional economic science can´t answer.

In this blog and in the ETVOL “Economy Issue” you and David S. Wilson have pointed out repeatedly that biological success (fitness) is measure of RELATIVE success, whereas Economic´s number one assumption is that rational agents try to maximize their ABSOLUTE utility.

For example, in an ultimatum game the rational solution for the responder is to accept any offer: usually the minimum amount possible. I think this rationality could explain pretty easily any increase of inequality and the “Mathew effect”; Game theory explicitly states that a rational responder would be indifferent if he is offered “zero”.

But there are some problems to this model. First: Violence doesn´t come from “indifference”. Second: Real world offers approach “fifty-fifty” and not “zero”.

Many responders can accept inequal offers that are not fifty-fifty but, and this is my point, THEY ARE NOT INDIFFERENT TO IT. Some thing makes the responders reject offers that are well above the rational offer. Why is that?…

My point is that, if a responder perceives the proposer as a “relative” competitor, he or she will not be pleased with an offer worse than fifty-fifty. The more the offer departs from equality the more outraged the responder will become towards the proposer, even to the point of rejecting the offer. That rejection is, strictly speaking, a form of punishment; It could be seen as a form of violence but that is not necessarily the case. Refusing a deal is not violence at all though it can be considered punishment if it implies costs for both agents. As Richerson says a strike is an example of this: a non-violent mass rejection of a (perceived) inequal deal.

So I agree with you, Peter, in that there is indeed a force, ignored by traditional economic thought, that makes rational agents quantitatively sensitive to inequality: competition in terms of relative success. As inequality increases, outrage proportionally increases, sometimes to the point of coordinating collective punishment, violent or not.

To sum it up: the “absolute” rationality can explain arbitrary increases of inequality and the Matthew effect, but a “relative” rationality can explain the oppossite. Oppossite forces can generate dynamic equilibria.

Ross Hartshorn

I feel like I should also bring up the Mancur Olson theory: inequality results from a smaller and smaller group being required in order to get a lock on a majority of the resources, but in order to do this they need to have ever-more elaborate (and fragile) machinery to manipulate the political machinery of the status quo. A defeat in a major war, then, is much more likely to result in a decrease in inequality than a victory, although a pyrrhic victory might also disrupt things enough to wreck the political machinery used to secure a disproportionate share of resources.

He used a comparison of Southern vs. Northern states after the Civil War, and defeated vs. victorious powers in WWII to bolster his theory. He didn’t live long enough to see another (peaceful) example, wherein Germany surged ahead of Japan because after 1989 their system was disrupted (this time peacefully, but merging East and West Germany), whereas Japan’s was not.

In this theory, what is required is not violence per se but perhaps also a political disruption large enough to wreck the establishment machinery for lobbying, controlling popular opinion, etc. I’m not sure if I’m convinced, but it’s plausible, and worth bringing up.

Of course, Mancur Olson’s books cover this a lot better than I just did.

edwardturner

Inequality really kicks in when society becomes more like a competition with increasingly complex set of rules.

Added social complexity increases what first-person-shooter computer gamers might call the “skill gap” between the veterans (old people, old money) and the newbies (young people, new money).

When the skill gap is large it takes time and practice to gain the acquired knowledge that is necessary to excel – but the rewards for doing so are that when you get good you really stand out from the crowd.

Not many people are going to catch you soon because they cannot come in and prosper just because they have great natural ability at the game.

In contrast, when the skill gap is small there is less acquired knowledge to learn so it takes less time for new players to compete with your ability level. A newbie at the game, who is naturally talented (great reactions and tactical brain) will quickly compete successfully with the most experienced gamers (who have the better equipment, knowledge of maps etc).

To an extent a society is like a game. It has a set of rules and changing the rules can change the game. Making the rules more complicated will increase inequality because it will be easier for the old people to out-compete the young people. With the rules made simpler young people will be able to rise more easily purely on the back of their own talent and hard work.

Corporate law is a very obvious way in which modern society has got very much more complicated over the last 200 years. Most of the laws that the secular courts enforce today are not common laws or natural laws, they are corporate laws (speeding fines, tv licenses, debts). It’s artificial complications on top of the fundamental laws (human rights etc.) that humans have which increases the “skill gap” of life which in turn causes inequality to increase.

The “freeman” movement in the UK is a reaction against this gap. UK residents can watch the informative documentary on youtube.

https://www.youtube.com/watch?v=7sArXw6ajNg
http://www.fmotl.com/

Ian Christie

Thanks for this piece.
Olson’s work is important as a previous writer has mentioned in the comments.

See also the game-theoretic study ECONOMIC ORIGINS OF DICTATORSHIP AND DEMOCRACY by Acemoglu and Robinson; their follow-up study of inclusive and extractive institutions is also relevant. Briefly, they back the argument that elites will make concessions that reduce inequality if they have sufficient fear of systemic risk to their position (e.g. revolution).

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