Pragmatic Pluralism 8: Inequality

This chapter provides a map through the complex jungle of economic theories. There are many different theoretical approaches, and each aspect of the economy has been analysed by a number of different ones. However, it is neither feasible nor productive for students to engage with every possible angle for every topic. Hence, the chapters on different topics, together with Building Block 8: Economic Theories, sets out an alternative approach: pragmatic pluralism. Rather than pursuing the extreme of either only focusing on one approach, or including every possible strand of thought for every topic, we propose a pragmatic middle ground: teaching a select number of approaches for each topic. In this way, it is possible to introduce students to the variety and diversity of economic thinking, whilst still having enough time and space to properly discuss each of the insights in detail with them.

Topics:

Inequality is a hotly debated topic both within economics as well as outside of it in other academic disciplines, in politics and in society at large. As such, there are also many dimensions and aspects of inequality to which various thinkers and activists have drawn attention to, from economic inequality based on class to gender and ethnicity, or race. Another key question is: inequality in what? Market or disposable income, wealth, power, influence, opportunities, happiness or health, to just name a few. A key question in the field is whether people are fairly rewarded for their work, or whether power differences prevent equitable remuneration. In short, whether market inequalities are fair or not. Another core question in the field is how different forms of inequality relate and interact with each other. Whether being a black woman, for example, is simply about adding up the effects of being black and female, or whether combinations have their own unique characteristics?

Main opposing perspectives

■ Marxian political economy: Exploitation

■ Neoclassical economics: You get what you deserve

Main complementary perspective

□ Feminist economics: Intersectionality is crucial to understand inequalities

Additional perspectives and insights

+ Post-Keynesian economics: Equity generally promotes efficiency

+ Austrian school: Social justice is a nonsensical idea

+ Other: Merit-driven inequality is socially undesirable

+ Behavioural economics: Inequality is relative, and mostly disliked

+ Complexity economics: Marx was right – there are two classes

+ Other: Piketty’s r>g

A core debate about market inequality is whether it should be understood as being fair and meritocratic, or not. The former argue that individuals, at least in a capitalist, or market, economy, freely make deals with each other to make their lives better and in doing so are rewarded for their personal performance and successes. Others, however, argue capitalism is an unjust system in which hierarchical power relations force some to work for others, resulting in their exploitation. In sum, the argument is about whether capitalism is a system in which ‘the pie’ is fairly and widely shared, or whether it is a system that creates unparalleled wealth next to desperate poverty.

Marxian political economy: Building on earlier ideas, in particular classical political economy, Marxian scholars look at societies as being made up by socio-economic classes: “In ancient Rome we have patricians, knights, plebeians, slaves; in the Middle Ages, feudal lords, vassals, guild-masters, journeymen, apprentices, serfs; in almost all of these classes, again, subordinate gradations” (Marx & Engels, 1848, p. 2). In industrial capitalism, two classes are key: the capitalists, who own the means of production, and the workers, who have to sell their labour in order to make a living. And within these broad categories, one could also add more differentiation. Examples of old categories are the ‘haute bourgeoisie’, referring to bankers and industrialists, and the ‘petite bourgeoisie’, associated with small businessmen and white-collar workers. And a more recent example is the ‘precariat’, which is characterized by precariousness due to job insecurity, identity insecurity, and a lack of control over one’s own time because of workfare policies.

The core argument is that while workers seem to be free and engaging in voluntary transactions to benefit themselves under capitalism, they are not. Workers’ labour is not truly voluntary as they do not have the means of production and thus are forced to sell their labour to capitalists, who do own the means of production, or else live in poverty and starve. These fundamentally unequal bargaining positions between employees and employers allow the latter to exploit the former, by appropriating part of the value employees produce. For the functioning of this capitalist system, it is crucial that the state and the law enforce the existing unequal distribution of private property. In Marxian thought, politics and the economy should therefore be seen as inherently intertwined, rather than as separate and unrelated social domains.

Among those who view market inequalities as unfair, there is a broad range of opinions on what should be done about it. These range from those who argue for redistributing income and social welfare programs to prevent extreme poverty, to those who advocate changing the economic structures that give rise to such unfair market inequalities in the first place, sometimes called predistribution. 

Neoclassical economics: During the late 19th century, the young neoclassical approach tried to counter Marxian, institutionalist and other ideas which argued that capitalism is an unfair system in which workers are exploited. John Bates Clark in The Distribution of Wealth, for example, took it upon himself to prove scientifically that the market inequalities were justified and fair, rather than excessive and unjust. Clark argued that the market rewards the factors of production, including both capital and labour, equally to what they contribute to the production process, more precisely the market value of their marginal product. In other words, everyone gets their fair share based on their productivity.

To understand inequalities, one thus has to look at differences in talents and education, as these make people more or less productive. It can also be that the context changes and the market demand for certain types of skills has increased or decreased. To explain the rise in income inequality of the last decades, for example, neoclassical economists have argued that technological change has favoured higher educated workers relative to lower educated workers, also known as skill-biased technological change (SBTC). 

Neoclassical economists have theorized that competitive markets would cause discrimination to disappear in the long run, as those who discriminate hurt themselves economically by forgoing the best market deals. Becker theorized that people could have a ‘taste’, or preference, for discrimination and are therefore willing to pay more for their ‘preferred’ groups than for discriminated groups. Another hypothesis is that discrimination is rational and non-biased market behavior as people have limited information and thus utilize all indicators they observe, even if they are imperfect. This theory of statistical discrimination argues it is too expensive, and often impossible, to treat everyone as an individual. As a result, people rely on statistics about groups to judge individuals. It should be noted that a key and controversial assumption in this approach is that discriminated groups are on average less productive and therefore generally treated as such, even though there are individual exceptions. In this way, statistical discrimination is thus an efficient way of dealing with information costs.

A key insight of feminist scholars that has come to prominence in the late 20th century is that different forms of social and economic inequality intersect with each other and in doing so create unique combinations. This concept of ‘intersectionality’ was initially developed to better understand how it could be that the issues of black women in the US were more neglected than what one would expect if one would simply add the gender and race factors. The feminist movement was largely dominated by white middle-class women and the civil rights movement, despite crucially relying on many leading black women, was spearheaded by male black leaders. As such, the idea came up that one should directly look at combinations of factors, the intersectionalities, rather than putting gender, race or class first.

In this perspective, inequalities are understood as overlapping systems of power with social identities that can be oppressing as well as empowering. A key related idea is that one’s personal experiences and social position, one’s ‘standpoint’, shape how one looks at and understands the world. According to this standpoint theory, social identities based on race, gender or class play an important role, but do not explain everything in an essentialist way as individual experiences can differ between people of the same social category. Nevertheless, it is argued that marginalized groups are in an unique position to enrich and improve our understanding of the economy because their perspectives and experiences have been underrepresented in economics. When one teaches or researches a topic, it thus is important to be aware of one’s social position and acknowledge that others, and especially those with different standpoints, might observe different aspects of the topic at hand.

Post-Keynesian economics: Post-Keynesian economists have drawn attention to the macroeconomic effects of inequality. Poorer people spend a greater proportion of their income than rich people do, in jargon they have a higher propensities to consume. Because of this, growing inequality can be bad for growth as it can lead to a fall in consumer demand, which can only temporarily be prevented by expanding private borrowing. This chain of reasoning as well as various empirical studies have led numerous economists to argue that equity and efficiency can go together and strengthen each other. This is in contrast to the idea, prevalent among neoclassical and Austrian thinkers, that there generally is a trade-off between equity and efficiency, especially when it comes to government intervention in the private sector. 

The different understandings of the economy lead to different policy conclusions. Marxian political economy is associated with overthrowing capitalism and eliminating class inequality all together, while (post-)Keynesian economics is often linked to the idea of saving capitalism with state intervention and redistribution to lessening inequality. Advocates of redistribution argue that it not only leads to fairer distributions of wealth and income, but that it also stimulates the economy by increasing demand. Furthermore, they argue redistribution is efficient because it reduces the social costs associated with high economic inequality, such as increasing physical and mental illnesses, social fracturing and polarization, increasing crime and drug abuse, increasing gambling and advertising expenditures, and decreasing educational performances and child development (Wilkinson & Pickett, 2009). Opponents of redistribution argue the government should focus its efforts on securing competition and free markets as these will ensure market outcomes are fair and efficient. Furthermore, they argue that inequality motivates people to behave productively and efficiently, as they see that economic success is rewarded with wealth. Finally, there are also neoclassical economists who argue that efficiency and distribution are entirely unrelated to each other, often referring to the second theorem of welfare economics which says that any distribution can theoretically come to an efficient (Pareto optimal) outcome.

Austrian school: Few argue against equality of opportunity, but various Austrian theorists, such as Friedrich Hayek in The Mirage of Social Justice, do. Hayek argued that market outcomes to a large extent depend on random factors and luck, and people their rewards can thus not be attributed to individual’s performances, as neoclassical economists do. Nevertheless, he argues it is wrong to call market outcomes unjust, as he asserts that ascribing moral judgments to societal systems is mistaken and even ‘primitive’. Modern capitalist societies are characterized by a diversity of values, so the focus should be on protecting people’s (market) freedom and (property) rights so that the (free) market can make everyone better off. The whole idea of social justice, in this perspective, is a ‘mirage’ and should be abandoned. If the government would try to ensure equality of opportunity, it would distort the otherwise efficient market allocation of resources and thereby leaving everyone, including the poor and disadvantaged, worse off than if the market would be left alone. Capitalism should thus be defended by emphasising its efficiency and not by claiming it to be, or trying to make it, a meritocracy, in which individual talents and effort rather than birth, determine success.

Other: This line of reasoning is in stark contrast to other critics of meritocracy, who argue that (large) inequalities of outcome are not desirable even if equality of opportunity would be ensured. Micheal Sandel in The Tyranny of Merit, for example, argues that meritocracy undermines social cohesion and causes social polarization. He criticizes the misuse of meritocracy to justify unequal outcomes by wrongly claiming people had equal chances. Educational outcomes, for example, are often used to claim vastly unequal outcomes are meritocratic and therefore just, despite the fact that a vast literature of research shows how educational outcomes are heavily dependent on socio-economic contextual factors and are thus not simply a reflection of individual merit. But Sandel’s more fundamental point is that the ideal of meritocracy is flawed itself. Meritocracy, or just the idea of it, leads to a demoralising individualism in which the ‘successful’ develop hubris, believing their affluence is the result of their virtue, and the ‘losers’ are humiliated by making them believe their failure is their own fault. Rather than aiming for a (very) unequal society with social mobility based on merit, he argues we should strive towards a society in which everyone can have a good life and a recognized and respected role in contributing to the common good. According to Sandel, the corona crisis could set us in the right direction as it made us realize the social value of many low paying jobs which were deemed ‘essential’, from nurses and childcare workers to delivery workers and grocery store clerks. 

Behavioural economics: Experimental studies consistently find that human beings are reciprocal in their behavior and have inequality aversion, sometimes referred to as social preferences. Most people favour ‘fair’ outcomes, even when it costs themselves something. Interestingly, research also finds that for people’s happiness it is especially their income relative to their sociological reference group(s), rather than just its absolute level, that matters. Also in contrast to neoclassical theory, behavioural economists found that increased income only makes people happier up until one point, after which more income contributes very little, if anything at all, to one’s happiness. Being poor, on the other hand, is found to have damaging effects on people’s cognitive capabilities. Poverty consumes people’s mental resources as they have to develop short-term survival strategies to cope with a hostile and stressful environment. This also helps explain why poor people, especially those who grew up as children in poverty, have higher risks of mental and physical illnesses and have more difficulty with long-term orientation and healthy behavior.

Complexity economics: Various economists and physicists, under the banner of complexity economics and econophysics, have applied methods from physics to study inequality. Trying to best describe empirical distributions with mathematical equations, the econophysicists came to a “two-class” theory of income distribution in which income coming from labour follows an exponential Boltzmann–Gibbs law distribution (thermal), and property income follows a Pareto power law distribution (superthermal). People have both forms of income, but for the bottom 97-99% of the income distribution labour income is most important and for the top 1-3% property income is critical. Furthermore, they found that while the income inequality within the bottom class of the distribution remains surprisingly stable over time, the upper tail is highly dynamic.

Other: Besides these empirical studies by complexity scholars, there have been many other recent empirical and data-driven studies of inequality within and between countries. The most famous of which is Piketty’s book ‘Capital in the Twenty-First Century’ in which he argues inequality is an inherent feature of capitalism that should be tackled through state intervention, and a global wealth tax in particular. A key argument in the book, which informs its main policy proposal, is that a core mechanism driving inequality is the fact that capital returns are persistently higher than economic growth rates (r>g).

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