Accounting for Inequality

Thanks in part to Occupy Wall Street, and in part to the media attention bestowed upon Thomas Piketty’s new book, Capital in the Twenty-first Century, the “distribution of wealth is one of today’s most widely discussed and controversial issues” [1]. ¹

A big problem with this important discussion, says Piketty, is that it is a “debate without data” [2]. The introduction and analysis of large data sets on inequality would seem to be his forte. Furthermore, he wants to look at data diachronically as its patterns evolve over time. These are clearly methodological strengths that encourage confidence in his work. Theoretical questions, however, also inevitably arise in the debates and controversies surrounding the meaning of the data.

The distribution of wealth has been given short shrift in most conventional economics textbooks, yet it is arguably the most basic element in our economic system. Where wealth comes from, how it is accumulated, its relationship to income flows and income inequality are topics usually absent in discussions among conventional economists. Piketty rightly counters this tendency, and advocates “putting the distributional question back at the heart of economic analysis” [15].

The high profile emergence of Piketty’s work raises our hopes and is to be welcomed. Furthermore, his heart seems to be in the right place: “There is little evidence that labor’s share in national income has increased significantly in a very long time” [22]. Also from 1980 to about 2000, he points out, the top 10 percent of income earners in the United States increased their share such that it is now about 50 percent of the national income [23]. These are weighty matters in terms of the wide-spread fairness and justice concerns given the pattern of intensifying inequality here and labor’s nearly total dependency on market-based access to necessities of life. Some interpretations of globalization have questioned whether intensifying inequalities are self-evidently tied to fairness and justice issues. It is suggested that globalization together with technological change might mean that income that would otherwise go the U.S. middle class might instead accrue to emerging middle classes and the poor in developing countries, and that it is not necessarily unjust that they catch up while middle-class incomes in the U.S. stagnate. Scott Sernau ² has argued to the contrary, and Piketty would seem to agree, ³ that globalization has led paradoxically to “worlds apart,” both within and between nations. Austerity policies, centering on forms of structural adjustment, have reduced social-needs-oriented government spending while subsidizing banking and investment institutions. Increasing exploitation is occurring today through the “race to the bottom” as global capitalism scours the world for the lowest wage labor markets and presses domestic labor for steep cuts. Policies of the World Bank, the International Monetary Fund, and NAFTA (North American Free Trade Agreement) have led to structural adjustments that exemplify policies of domination that hurt the poor and middle classes.

Most U.S. adults typically have little awareness of the nature of wealth or the pattern of its distribution in society. This generally also means lack of insight into the connection of income flows to relations of capitalist property (i.e. wealth) ownership and the commodification of labor and life. The distinction between an income flow from wealth, i.e. from the economic assets owned by a person or family (rent, interest, dividends, and profit) and income flow from labor (i.e. salary and wages) is key to critical understanding and its impacts will be elaborated below. An examination of these kinds of social dynamics is a vital part of a critical or radical pedagogy. A widely-used sociology text, Social Problems, by Macionis ⁴ stands out in this regard, pointing out that inequalities of wealth are linked to inequalities of life chances. “Life chances” is a technical term used to indicate the relative access a household has to the society’s economic resources: decent housing, health care, education, employment, etc. The greater the wealth in one’s household, the greater one’s life chances. Life chances (including access to jobs and income) are today being transferred away from the vast majority of households and redistributed to the advantage of the wealthiest.

A pattern of polarization has transpired with regard to incomes, over time, such that today “income inequality has soared to the highest levels since the Great Depression.” ⁵ “The increase in incomes of the top 1 percent from 2003 to 2005 exceeded total income of the poorest 20 percent of Americans. . . .” ⁶ In February 2013 Emmanuel Saez, of the University of California, Berkeley, reported that during the current recovery the incomes of the top 1 percent rose 11.2 percent, while the incomes of the remaining 99 percent fell by 0.4 percent. ⁷ Saez also reported that in the United States, “Excluding earnings from investment gains, the top 10 percent of earners took 46.5 percent of all income in 2011, the highest proportion since 1917.” ⁸

Investigating the origins of inequality and its intensification in the United States, my colleague Stephen Spartan and I have sought to understand the generative structures undergirding today’s increasingly unequal and irrational patterns of wealth and income distribution. ⁹ In the United States even the current recovery is a further indicator of a distorted political economy in which taxpayer/government subsidies to finance capital have permitted a redistribution of wealth to the advantage of the largest banks and high income individuals, reducing the global payroll. Governments can alter these patterns of inequality through macroeconomic interventions involving policies of taxation, central banks, and education. In the United States over the last several decades a rising tide of growth certainly did not lift all boats. The primary gains of globalization have accrued to the wealthiest; the wealth gap is the widest in decades. ¹⁰

Thomas Piketty’s study of capital and inequality begins with a standard tenet of national income accounting, that “[a]ll production must be distributed as income in one form or another, to either labor or capital . . . . National income = capital income + labor income” [45]. Further, “income can always be expressed as income from labor and income from capital” [242].

In other words, a key criterion in understanding inequality is the capital-labor split with regard to their respective shares of the national income. ¹¹ Spartan and I develop a model (see appendix A) that derives precisely from our shared understanding with Piketty as just described above: Ni = Ci + Li, where Ni is national income, Ci is capital income, and Li is labor income.

The first half of Piketty’s extensive analysis is taken up by his meticulous search for the historical development of global patterns of Ci as a percentage of Ni. Should this be increasing, as is indicated in the work of others highlighted above, this would have clear implications for the justice and fairness issues connected in our view to the reality of intensifying inequalities.

Clearly, if Ni (national income) and Li (labor income) are known quantities, then Ci (capital income) is easily determined. Our efforts were much more modest than those of Piketty; still, we proceeded in a straightforward manner to ascertain capital income by expressing the relationship Piketty acknowledged above (Ni = Ci + Li) in an equivalent form, namely as Ci = Ni – Li. Hence, we were able to determine Ci when Ni and Li were known in the economy’s manufacturing sector.

Piketty might have done this also, but in his work the analysis shifts almost immediately away from the Ni = Ci + Li relationship to an examination of what he calls the “First Fundamental Law of Capitalism” [52]. Piketty assigns α to represent capital income (which we have designated as Ci, above). The fundamental law of capitalism as he sees it is that α (or Ci) equals the product of r times ß, where r is the rate of return on capital and ß is the capital/income ratio [50]. Here we enter vast new data territory and a new assertion of variables standing in formal equilibrium with α or Ci. This method’s logic appears to achieve his objective, the determination of α (capital income, Ci), but for Piketty the research road to α and Ci takes a convoluted turn involving three new variables. This may take us where we want to go, or it may well lead him (and us) to inaccuracies and erroneous conclusions. His procedure to find Ci or α presumes that the total value of the capital stock of any economy may be confidently and immediately determined as well as the rate of return on capital overall (r).

Piketty acknowledges that a nation’s capital is comprised of a variety of assets: “residential capital, professional capital used by firms and government,” [51] farmland, housing stock, etc. [119]. Piketty [48-49] is not bothered that the dot.com bubble and the real estate bubble have made it clear distortions can inflate (and deflate) prices beyond real value. These factors would seem to pose insurmountable difficulties in accurately ascertaining the total value of capital stock. Such distortions would likewise introduce fluctuations in the rate of return or growth in sectors and subsectors of the economy, and damage our ability to assess r for the economy overall. Thus seeing “α = r X ß” as the fundamental law of capitalism [50-52] seems methodologically questionable. Because of the difficulty in gaining access to such data as well as uncertainties in assessing them, our methodology makes use instead of the basic formula that Piketty agrees to at the outset: Ni – Li = Ci. Thus the potential pitfalls of Piketty’s circuitous research route can be avoided. Let me explain our approach.

The standard methodology utilized to calculate the gross domestic product and national income looks at the amount of new wealth created, i.e. value added through production in each firm and each industry. In each sector of U.S. manufactures, for example, this is calculated by deducting the dollar costs of the inputs (supplies, raw materials, tools, fuel, electricity, etc.) from the dollar value of the outputs for each firm. Very importantly, these national income accounts—unlike conventional business accounts—do not include the “cost” of labor among the input costs in the conception of the production process they utilize. Instead, they treat workforce remuneration and capital remuneration as do Locke, Smith, and Marx: as income flows stemming from the value production process itself. ¹²

When looking at data on the gross domestic product and national income with regard to the United States, it makes sense to look first at that portion of the national income generated in manufacturing. This is because data in that sector are clearly reported to the U.S. Department of Commerce with regard to labor income from manufacturing and national income from manufacturing. This latter figure we can call Nim, and analogously consider it to be composed of Cim (capital income from manufacturing) and Lim (labor income from manufacturing). Thus: Nim = Cim + Lim. National income from manufacturing (Nim) minus labor income from manufacturing (Lim) = capital income from manufacturing (Cim), which may be restated as: Nim – Lim = Cim.

The Statistical Abstract of the United States 2011 (SAUS, sadly the U.S. Census Bureau terminated the collection of data for the Statistical Compendia program effective October 1, 2011, and since then the SAUS has no longer been published) includes the data we need in this regard from the U.S. Department of Commerce. See appendix B, below. In terms of the nomenclature of this table: “Value added by manufactures” is what we call Nim. The “total payroll” is what we call Lim, and Cim is found by subtracting Lim from Nim.

The Statistical Abstract of the United States 2011 reported the new wealth created (value added) in manufacturing in 2008 (the most recent available figure). This is contained in its Table 1006, http://www.census.gov/prod/2011pubs/11statab/manufact.pdf retrieved June 11, 2011.

That portion of the U.S. national income derived from manufacturing is given as $2,274,367 million. This is listed under the heading “Value Added by Manufactures.” Every dollar of the value added in U.S. manufacturing—for example this $2,274,367 million ¹³ —was distributed into one of the two basic income categories: 1) as Lim, income to the workforce―given as the payroll (wages and salaries)―$607,447 million; and 2) as Cim, income to owners and investors―as profit (including dividends), rent, and interest―which we can calculate (Nim – Lim = Cim) as the remainder: $1,666,920 million. Something very like this disproportionate division of the added value between capital income in manufacturing (Cim = 74 percent) and labor income in manufacturing (Lim = 26 percent)—the capital-labor split—is structured by unequal property relations into other sectors of the economy and into the division of the gross domestic product and national income overall. Spartan and I emphasize that incomes returned to capital and labor are structurally determined, i.e. conditioned primarily by societal, rather than individual, factors.

Looking further at some of the the disaggregated data from Table 1006, my appendix B below, we see, for example, that in category 3152, cut and sew apparel, total value added (in millions) was $7,385. The payroll (in millions) was $3,075. Therefore the amount returned to capital (in millions) was $4,310. This latter figure is an amount equal to 100 percent of what was paid to the workforce plus an extra 40 percent. What is true in this sector of the economy holds true in several other branches, often more dramatically. ¹⁴ In category 3118, bakeries and tortilla, total value added (in millions) was $34,108, the payroll was $9,442; hence $24,666 was returned to capital, more than double the amount returned to labor. The pattern of returns to capital and labor is clear in every sector and sub-sector of manufacturing.

At the start of his book Piketty asks: “But what do we really know about . . . [the evolution of the capital-labor split] over the long term?” [242]. Here he raises a good question, one that he only gets to, however, in the second half of this major work. In the first half, among other things, Piketty takes pains to make clear his own theoretical perspective, and explains that (growing up at the time he did) he: “was vaccinated for life against the conventional but lazy rhetoric of anticapitalism.” “If capital plays a useful role in the process of production, it is natural that it should be paid” [423]. He declares he has “no interest in denouncing inequality or capitalism per se—especially since social inequalities are not themselves a problem as long as they are justified . . . ” [31].

In terms of the justification for labor’s share, it is conventionally held that the increasing use of labor-saving technology reduces labor’s role in production; hence reductions in the share of the value added that will be distributed as remuneration to labor are legitimate. Herbert Marcuse noted in One-dimensional Man (1964) that manufacturing would utilize ever-increasing automation technologies such that labor’s role would be increasingly diminished and ultimately eliminated. He did not conclude, however, that this should mean that the bulk of the compensation from manufacturing should go to capitalist owners. Instead he saw this tendency as lowering the real per-unit costs of production almost to nothing and making abundance a historical possibility. ¹⁵ We should also understand that the technologies are often developed through a web of scientific support activities at public research institutions, not by manufacturers themselves. They build upon productive forces that are part of a social fabric, such that the gains of technological advance should properly accrue to the public as commonwealth. Under capitalism, however, the powers of technology are used to intensify reductions in labor compensation through de-skilling and outsourcing/offshoring.

A key theme in Piketty’s work and ours is thus the notion of a capital-labor split in the distribution of the national income. Piketty asks: what is the “right” split between capital and labor [41, 263]? We on the other hand (as apparently indolent anticapitalists) offer Marx’s radical admonition to the rising labor force: “Instead of the conservative motto ‘A fair day’s wage for a fair day’s work!’ they should inscribe on their banner the revolutionary watchword ‘Abolition of the wages system.’” ¹⁶

Piketty tells us that the split of the national income between labor and capital is traditionally calculated to be “[r]oughly 65-70 percent for wages and other income from labor and 30-35 percent for profits, rent, and other income from capital” [41, 583]. He notes at the outset however that the reality is more complicated than that. The complications take up the first two hundred pages of his book (more on this below). Our calculation of the split between labor and capital (looking specifically at the capital-labor shares in the manufacturing sector of the United States and using U.S. Census Bureau data, as we have seen above) has these proportions just the other way round, with the lion’s share (almost three-quarters) going to capital! ¹⁷ In the light of this official government information, the thought that businesses can reduce inequality by “creating jobs” would seem to be politically deceptive and pathetic for labor, given that each quantity q of income flow from such a job is generally accompanied (in the private manufacturing sector) by an income flow of 3q to capital.

Our analysis, outlined above, utilizes a straightforward model of income flows. Piketty side-steps this in what to us seems to be a curious circumvention. Thus he begins his analysis of the changing features of inequality in the world by asserting: “The most fruitful way to understand these changes is to analyze the evolution of the capital/income ratio (that is, the ratio of the total stock of capital to the annual flow of income) rather than focus exclusively on the capital-labor split (that is, the share of income going to capital and labor, respectively)” [42]. With this, his study is off in a new direction, yet a few pages later the analysis swerves and takes a back flip: “The capital/income ratio for the country as a whole tells us nothing about inequalities within the country. But β does measure the overall importance of capital in a society, so analyzing this ratio is a necessary first step in the study of inequality.” ¹⁸ Then we are in for 1) an assertion that seems designed to reduce what he will consider as income from capital (Ci): “a portion of what is called ‘the income of capital’ may be remuneration for entrepreneurial labor, and this should no doubt be treated as we treat other forms of labor,” [41] and 2) a big surprise: “. . . this spectacular increase in inequality largely reflects an unprecedented explosion of very elevated incomes from labor, a veritable separation of the top managers of large firms from the rest of the population” [24]. Piketty may have deftly set the stage to underestimate income to capital to a very significant degree, helpful also to his reinterpretation of the meaning of rising inequality overall.

Piketty tells us that, in France and the United States especially, executive supersalaries [276, 298] are the factor most responsible for the intensifying inequalities. Piketty’s method also overestimates the labor share of the national income because he defines executive pay as a remuneration for labor. He finds that of the top 10 percent of income earners in the United States, only the top 1 percent receive most of their income from capital [277, 280]. The bottom 9 percent of these get their remuneration primarily from their executive labor [279], though he admits that this remuneration cannot be adequately demonstrated as deserved in terms of the executives’ own marginal productivity [308, 330]. Rather the norms of the corporate boards’ compensation committees have become permissive [333]!

The failure of the theory of marginal productivity to explain CEO compensation and its disjunction from the practices of corporate compensation committees seems a blatant contradiction. It raises two immediate questions: if the top executives themselves do not produce a major share of the substance of their own remuneration, who does? And if much of this compensation is given as stock or stock options, then must not this portion be considered apart from Li (Labor income) as a redistribution or transfer of a property claim on assets composed of already extant wealth/capital? Compensation through rights to stock ownership, if this is to be considered a flow from the value added through the production process, must be seen by definition in national income accounting as Ci (Capital income). Compensation packages of top executives used to recruit and retain skilled managerial and technical labor are composed of several components, reflecting a multiple class positioning. Salary due to their marginal product might with some warrant be seen as labor compensation. Compensation beyond their marginal product, which Piketty acknowledges as routine, i.e. bonuses, stock options, etc., may be due to their relative monopolization of a key decision-making position and the seeking of rent-like possibilities, rather than to the scarcity of their talents within a managerial labor pool.

Piketty’s Capital in the Twenty-first Century is significantly burdened by obfuscation. This becomes abundantly clear when Piketty diminishes the question of income from inherited wealth as a social justice issue: “To be sure income from labor is not always equitably distributed, and it would be unfair to reduce the question of social justice to the importance of income from labor versus income from inherited wealth” [241]. Starting with a consideration of “Inequalities with Respect to Labor and Capital,” [242] any ostensible concern Piketty might have had with the injustice of the given patterns of the capital-labor split is recast here as a discourse on “Two Worlds,” which becomes a 100-plus page excursion into a description of inequalities internal to the flow of income to labor that are considered in disjunction from inequalities internal to the flow of income to capital! We are treated to Table 7.1 on “Inequality of labor income across time and space” [247]. Table 7.2 presents “Inequality of capital ownership across time and space” [248]. Table 7.3 gives us “Inequality of total income (labor and capital) across time and space,” [249] and hypotheses are proffered concerning the meaning of inequality in the United States. So we read, for example, how “inequality with respect to capital is always greater than inequality with respect to labor” [244]. Further, “If inequalities are seen as justified, say because they seem to be a consequence of a choice by the rich to work harder or more efficiently than the poor . . . then it is perfectly possible for the concentration of income to set new historical records. That is why I indicate in Table 7.3 that the United States may set a new record around 2030 if inequality of income from labor—and to a lesser extent inequality of ownership of capital—continue to increase as they have done in recent decades. . . .” [This would be] “a very inegalitarian society, but one in which the peak of the income hierarchy is dominated by very high incomes from labor rather than inherited wealth” [264-265]. “[W]hat primarily characterizes the United States at the moment is a record level of inequality of income from labor . . . together with a level of inequality of wealth less extreme than the levels observed in traditional societies or in Europe in the period 1900-1910” [265].

If top incomes have grown far in excess of the economy’s overall rate of growth, something had to give. These grew at the expense of what? Piketty tells us the top incomes grew at the expense of many in the labor force, but this shift is not to be explained by heightened returns to capital; rather by heightened returns to supersalaried executives, in his estimation, labor’s elite. Thus some of the key causes and consequences of capitalist inequality in its historical and political context are diminished: it is not that following decades of labor speedup, ¹⁹ the recovery continues to facilitate enormous amounts of capital accumulation ²⁰ and the intensification of poverty. ²¹ Piketty does not see inequality as primarily a matter of the structural relationships in the economic arena between propertied and non-propertied segments of populations. Capitalism generates some extreme inequalities, but apparently not primarily through a system of appropriation embedded within the relationship of wage labor to capital in the distribution process. In his view U.S. capitalism is less a society dominated by a parasitic rentier class than by (non-parasitic?) supermanagers. Stiglitz and Greider are renowned for macroeconomic analyses demonstrating just the opposite. ²²

Entrenched CEOs can gain so much structural power that they are virtually independent of boards of directors and corporate compensation committees, directing the strategic mission and the organizational culture, and acquiring unearned advantages (rents). At the same time their decisions may be exploitative and detrimental to the labor force overall. Critical Marxists like Erik Olin Wright have demonstrated in contrast to Piketty that certain class locations can exhibit overlap and structural social complexity. ²³ Supersalaried executives should not be seen as labor’s elite, but rather as occupying interpenetrating class locations. This shows why such supersalaries should not be counted as remuneration to labor. Wright’s dialectical conception of class and multiple class positioning sets my analysis apart from Piketty’s, and leads to different conclusions. Here we see that the real debate revolves not around data, but rather around the interpretation of the data, theory.

Seldom discussed among students (or among faculty) is the question of where wealth comes from or the nature of the relationship of wealth to labor. These issues were first formulated, and for many economists settled without controversy, in the classical economic theory of John Locke and Adam Smith. As is well known, they held that a person’s labor is the real source of all wealth and property that one might have the right to call one’s own. Locke emphasized the natural equality of human beings and that nature was given to humanity in common. My perspective builds upon Locke and Smith, but stresses with Marx that labor is a social process; that the value created through labor is most genuinely measured by socially necessary labor time and its product rightfully belongs to the labor force as a body, not to individuals as such, i.e. grounding a theory of common ownership and social justice. Where Locke and Smith saw individual labor as the source of private property, in an atomistic (Robinsonian) manner, Marx recognized that all humans are born into a social context. Humanity’s earliest customs, i.e. communal production, shared ownership, and solidarity, assured that the needs of all were met, i.e. including those not directly involved in production like children, the disabled, and the elderly. This right of the commonwealth to govern itself, and humanity’s earliest ethic of holding property in common, derive only secondarily from factual individual contributions to production; they are rooted primarily in our essentially shared species nature as humans, as empathic social beings. Communal labor sustained human life and human development. When commodified as it is today, labor’s wealth-creating activity is no longer a good in itself. The overall “value” of the activity of the workforce, governed by capitalist property relations, is reduced to its aggregate payroll. The workforce is never fully remunerated for its contribution to the production process precisely because its contribution, when commodified through the labor market, tends to be reduced to the equivalent of the bare cost of labor force reproduction, and the “surplus” is appropriated as property by powerful non-producers.

This essay has questioned critical aspects of Piketty’s methodology, use, and interpretation of data, as well as his conventional assumptions on the meaning of inequality, the origins of income and wealth, and the nature of economic justice. It urges that we need to get beyond Piketty to understand both capital and inequality; likewise it advocates for a radical political economy that stresses the transformation of commodified labor into decommodified public work, work for the public good, commonwork for a commonwealth. “The very achievements of capitalism have brought about its obsolescence and the possibility of the alternative!” ²⁴