Economy Studying: Income Inequality

Introduction

Most governments across the world have applied some of the remedies prescribed by the 19^th century economists. Some of the solutions applied include progressive tax rates, low population growth rates, minimum wage rates, and educational training. These remedies appear inadequate in preventing the prevalence of income inequality.

Even in advanced economies, they cannot stop increasing inequality. A surplus of workers in the labor market justifies lower wage rates through the market mechanism. Unemployment is persistent through all countries, despite training initiatives. On the other hand, abstract mathematical expressions have become the main form of studying and presenting economics.

Discussion

One might think that Ricardo’s solution was only applicable at a time when landlords were wealthier through collecting rent. Ricardo considered that “the only logical and politically acceptable answer was to impose a steadily increasing tax on land rents”.¹ Today, it is still applicable if land rents are replaced with personal and corporate income. Taxation is the only logical and politically way of taking more from high income earners and less from low income earners without creating higher political tension. There is no direct way of taking money from the wealthy and distributing it to the poor unless they give it out voluntarily as philanthropy.

Piketty talks about progressive tax, which has been applied in both advanced and developing economies.² Imposing high tax rates is one of the ways of reducing the rate at which capital owners accumulate wealth. It does not effectively redistribute wealth rather than alleviate the welfare of the poor by creating public utilities. It works in almost the same manner as charity. Taxation does not stop increasing accumulation of wealth by the rich. However, it prevents the occurrence of Marx’s idea on the “Principle of infinite accumulation”.³ Without progressive tax, I perceive that the infinite accumulation of wealth by the rich would be the end result after several centuries of doing business.

Technology has been able to protect the world from experiencing the miseries predicted by Malthus.⁴ On the other hand, it appears unable to redistribute wealth within countries. It has shown the ability to redistribute income across countries through technology diffusion as in the case the emerging economies.

China has experienced protests of income inequality.⁵ It is an indication that even emerging economies may still experience income inequality despite adopting new more productive methods of production. It is not a surprise because advanced economies have experienced divergent income levels, even though they are pioneers in using the more productive methods. It appears that technology diffusion also provides ambiguous results within economies similar to the mobility of capital and labor.⁶

In a similar view as Piketty, I think that advanced economies should be at that point where the convergence of income levels occurs through technology. When most people in advanced economies are considered middle-income earners, the wealthy have moved further to higher income levels by trading in the global market. The global market is not easily accessible to individuals and small firms. Individual skills can benefit on the global market through working for the larger firms.

One of the ways through which technology is supposed to reduce income inequality is through productivity. However, as productivity increases a firm needs fewer workers. If it needs more workers with increasing efficiency and productivity, then there must be a firm somewhere else that is shutting down because it is becoming less competitive. The author says “growth can harm some groups when benefitting others”.⁷ It occurs in the case where China has substituted advanced economies in the global market.

There is a drive to produce more commodities with the lowest quantity of inputs. For those firms that lay off workers as a result of productivity, the workers can occupy the labor market. It creates a higher level of unemployment because there is a lag of time between reducing the number of workers and the creation of new jobs. With more workers in the labor markets, the laws of supply and demand proceed to undercut wage rates. When people are waiting for technology to take charge, the capitalists have become wealthier by paying lower wage rates.

Unemployment is one of the factors that will always reinforce income inequality. Technology diffusion cannot eliminate unemployment because unemployment is one of the factors that support favorable conditions for trade through lower wage rates. It becomes necessary for most governments across the globe to set the legal minimum wage rate to protect the capital owners from exploiting the opportunity for lower wages.

Lower wage rates will be persistent provided that there is unemployment. I consider a situation where an employer can find an employee who can accept lower wages because there are many workers in the labor market who cannot hesitate for a job opportunity. If there is very little unemployment, employers will need to give higher and more attractive wage rates to persuade employees to exchange job positions between firms. With minimal unemployment, the employers will have no option but to pay higher wages.

Another aspect of technology is that it creates a surplus of lowly skilled labor and a scarcity of highly skilled labor. With a surplus of lowly skilled labor, they can be paid lower wage rates and the highly skilled can be paid very high wage rates. As Piketty suggests, “top earners can quickly separate themselves from the rest by a wide margin”.⁸

What we need to find out is the number of top earners. If I am working in a large bank, the top earners may be less than ten considering the president and the vice presidents in every department. On the other hand, the lower level workers are counted in thousands. From this, you can get a clear picture of how many top earners will be separated from the rest. It works to create income divergence.

I concur with the author that knowledge and appropriate skills are a powerful force of income convergence.⁹ Indeed, it increases mobility through social classes. However, there are a few people within economies who have climbed through the ranks to be among the wealthy. There are those who have gained wealth by being innovators and those who are in top management positions. Thousands of students graduate each year with the knowledge and appropriate skills. Firms can only hire a few because they have to manage labor costs.

Not all of us with knowledge and appropriate skills can be employed as managers to be wealthy neither can we all be innovators. There is only one president in a country and there is only one president in a firm, despite the fact that many are willing to do that job. There are more graduates trained in mass communication than all studios, radio stations, and TV stations can hire. The supply and demand mechanism creates its own equilibrium. Knowledge and skills uplifts many to become middle-income earners, but it does not stop income divergence.

Piketty has referred to China as attracting capital because it has the appropriate skills.¹⁰ I think the main forces that attracted capital in China are lower labor costs and the large local market. If skills were the only determinant, advanced economies would be more preferred than China. Lower labor costs in China do not reduce income inequality. Capitalists are targeting China because it offers more returns to capital than advanced economies. The end result is that more income inequality among individuals occurs, even though the GDP may indicate that the country is getting wealthier. Today, China leads in creating inequality.¹¹

Piketty claims that policies on taxation and finance are some of the key factors that have contributed to the increase of inequality.¹² I am not sure of the effects of taxation. However, I am very sure that finance increases inequality. Only the wealthy can easily get finance to start new businesses and expand existing ones. The wealthy are also likely to be charged a lower interest rate because they provide collateral. As a middle-income earner, the commercial bank will require that I provide my pay slip to ascertain that I usually receive regular streams of cash flow. I am considered riskier, so they may charge me a higher interest rate. Large companies are usually charged very low interest rates compared to individuals, which increases income divergence.

I would like to open a fast food shop that sells seafood delicacies, but I have to save for a very long time before I can set it up. If I succeed in one shop, I would like to open several shops. However, I may need to wait longer to have enough capital to convince banks to provide additional capital. The wealth of the rich is enough to convince banks to provide additional cash. As a result, the wealthy grab more business opportunities than those who rely only on wages. The money creation process of banks assists the wealthy to become wealthier discriminately.

The author claims that the tragedies predicted by Malthus, Ricardo and Marx have passed without happening. I realize that economies around the world have been able to avoid the predicted miseries partly because they have applied some of the remedies given by the 19^th century economists. For example, most advanced economies have taken measures to reduce population growth. Most advanced economies have a lower population growth rate compared with their economic growth rate. Most economies have used progressive tax to reduce the rate at which the wealthy are getting wealthier.

Countries have set minimum wages despite some economists protesting that the market mechanism should set its own wage rate. The persistent unemployment would have ensured that workers are underpaid without the legal minimum wage rate set by governments. The predictions have not occurred. However, we have also changed the factors that the 19^th century economists considered to make predictions.

When I began my course in economics, I wondered why every concept in economics has to be expressed in mathematical terms, considering that it was a social science. Knowledge of advanced mathematics is essential to study economics after the undergraduate level.¹³ Even at the undergraduate level, mathematical skills provide a great advantage.

Differentiation was among the first calculations, I came across. It was the differentiation of the production functions with respect to quantity. It is used to determine the right price or quantity to produce to obtain optimal returns. However, in my small vegetable business I realized that markup is the easily applicable method. If a business does not provide the right markup, I would shut it down. If the goods are selling very fast, I would increase the price.

I realized that the maximizing formula used in economics gives the end result after all these price and quantity adjustments have occurred. It is abstract, but it explains what has happened to find a stable price known as the equilibrium price. The only challenge the economic formula creates is that in reality the production function is very complex to create. There are very many factors that affect a business’ quantity demanded and price. It may be difficult to quantify demand before you create the supply and generate some sales.

The mathematical methods used are abstract and the interpretation needs more competence from an economist. I agree with Piketty that modern economists have put more effort into making economics more mathematical. They want it to appear more scientific than other social sciences. In economics, a scholar has to use mathematical expressions to be considered seriously by peers.¹⁴ It occurs frequently that economists must use calculations to predict or explain markets without acknowledging that the variables they have used cannot be accurately measured.

Personally, I have usually doubted the accuracy of the GDP in developing economies. Later, I realized that even advanced economies have business transactions that are carried out without any records. I rarely meet the GDP referred to as an estimate, but as an accurate figure. In class, I realized that almost every economic concept has to be built from the abstract formulas, some of which cannot be quantified in the real world.

Economists have chosen to major in abstract calculations. The author states that “income, capital, the economic growth rate, and the rate of return on capital are abstract concepts”.¹⁵ Most economists use the abstract models to predict the future of markets and economies. The use of mathematical expression has been on an upward trend since the early 1990s.¹⁶

It declined in the 1980s. In the 1990s, it started to increase steadily. I think statistically analyzed historical data may be a better tool than models, which rely only on theories to make predictions. The models could not forecast the global financial crisis in 2008 or the great depression of 1929-1940.¹⁷ The outcome in both cases was different from what theorists expected. As an economist, I am not barred from using both historical data and models to make better predictions.

Conclusion

Governments have taken necessary steps to reduce the rate at which the rich accumulate capital through progressive taxation. Advanced economies have gone further to keep population growth at very low levels. Most governments support policies that encourage training for technical skills and knowledge. However, all these efforts appear inadequate to prevent increasing income inequality. Countries have different policies on capital accumulation.

Capitalists will always seek economies with less aggressive taxation policies to ensure that their capital grows at a higher rate than income. In the meantime, China provides that option. One thing that can be done is to have a policy that requires highly profitable firms to redistribute part of their profits as employee benefits. The first step will be to determine the acceptable level of profitability. Most economists would not support such an idea because it interferes with self-regulating markets.

Bibliography

Bernanke, Ben. Essays on the great depression. Princeton: Princeton University Press, 2009.

Beuke., Dan. “China’s Wealth Disparity Erupts in Wukan Protests.” Bloomberg Businessweek. 2011. Web.

Espinosa, Miguel, Carlos Rondon, and Mauricio Romero. “The Use of Mathematics and Its Effect over a Scholar’s Academic Career.” 2011, Web.

Piketty, Thomas. Capital in the Twenty-first century. Translated by Arthur Goldhammer. Cambridge: The Belknap Press of Harvard University, 2014.

Roberts, Dexter. “China’s Income-inequality Gap Widens beyond U.S. Levels.” Bloomberg Businessweek. 2014, Web.

Footnotes

1. Thomas Piketty, Capital in the Twenty-first century, trans. Arthur Goldhammer. (Cambridge: The Belknap Press of Harvard University, 2014), 7.
2. Thomas Piketty, Capital in the Twenty-first century, trans. Arthur Goldhammer. (Cambridge: The Belknap Press of Harvard University, 2014), 34.
3. Thomas Piketty, Capital in the Twenty-first century, trans. Arthur Goldhammer. (Cambridge: The Belknap Press of Harvard University, 2014), 9.
4. Thomas Piketty, Capital in the Twenty-first century, trans. Arthur Goldhammer. (Cambridge: The Belknap Press of Harvard University, 2014), 7.
5. Dan Beuke, “China’s Wealth Disparity Erupts in Wukan Protests,” Bloomberg Businessweek, 2011, Web.
6. Thomas Piketty, Capital in the Twenty-first century, trans. Arthur Goldhammer. (Cambridge: The Belknap Press of Harvard University, 2014), 21.
7. Thomas Piketty, Capital in the Twenty-first century, trans. Arthur Goldhammer. (Cambridge: The Belknap Press of Harvard University, 2014), 22.
8. Thomas Piketty, Capital in the Twenty-first century, trans. Arthur Goldhammer. (Cambridge: The Belknap Press of Harvard University, 2014), 23.
9. Thomas Piketty, Capital in the Twenty-first century, trans. Arthur Goldhammer. (Cambridge: The Belknap Press of Harvard University, 2014), 22.
10. Thomas Piketty, Capital in the Twenty-first century, trans. Arthur Goldhammer. (Cambridge: The Belknap Press of Harvard University, 2014), 22.
11. Dexter Roberts, “China’s Income-inequality Gap Widens beyond U.S. Levels,” Bloomberg Businessweek,  2014, Web.
12. Thomas Piketty, Capital in the Twenty-first century, trans. Arthur Goldhammer. (Cambridge: The Belknap Press of Harvard University, 2014), 20.
13. Miguel Espinosa, Carlos Rondon, and Mauricio Romero, “The Use of Mathematics and Its Effect over a Scholar’s Academic Career,” 2011, Web.
14. Miguel Espinosa, Carlos Rondon, and Mauricio Romero, “The Use of Mathematics and Its Effect over a Scholar’s Academic Career,” 2011, Web.
15. Thomas Piketty, Capital in the Twenty-first century, trans. Arthur Goldhammer. (Cambridge: The Belknap Press of Harvard University, 2014), 32.
16. Miguel Espinosa, Carlos Rondon, and Mauricio Romero, “The Use of Mathematics and Its Effect over a Scholar’s Academic Career,”  2011, Web.
17. Ben Bernanke, Essays on the great depression, (Princeton: Princeton University Press, 2009), 71.