Inequality and capitalism. Part 2
- Global inequality is decreasing
The point is often being made that a market economy is capable of decreasing inequality all by itself, without any massive state intervention in the secondary distribution. The current decrease in global inequality seems to prove this. I is presented as an indisputable fact that the catching up of developing countries in living standards show that market economies do not need inequality to function.
This statement is incorrect because the catching up process of developing countries is very different process from the normal process of economic development and also because catching-up itself creates new inequalities in these countries.
Take China, the country that dominated in purely quantitative terms these processes for the past thirty years, as an example. In China, decades of catching up with growth rates of up to ten percent per year have clearly led to improvements for a lot of very poor people (estimates are between 300 and 500 million people escaping from absolutely global poverty, say an income of one dollar day, to earning a few hundreds of dollars a year today). Looking at the global income distribution, the effect of poverty reduction is China, which is clearly attributable to the catching up of this large country, is so strong that it improves the global distribution of income. This happens although the distribution of income in all countries, including China, has become more unequal.
Let us look at this in a different way: on the one hand, there are the processes of catching up of developing countries, while on the other hand we have normal economic development in the developed world. Normal economic development takes place when the famous Schumpeterian pioneering entrepreneur has an idea for improving production processes or products or when she or he brings an entirely new product on the market. This means that these entrepreneurs increase productivity compared to their competitors and – given the same costs for all companies – achieve a higher profit or force their competitors into lower prices and a smaller share of the market.
The principle is that the Schumpeterian entrepreneur combines higher productivity in his factories with the existing wage level. This is innovation. Innovation increases inequality, it is in fact the most important way in which a market economy constantly produces new inequalities. But this inequality will disappear when the temporary monopoly of the innovator erodes over time – others innovate too, they catch up, no industrial secrets last forever. This competitive process eventually equals out profits and leads to price reductions that correspond to higher general productivity growth and higher real wages.
- The catching up of development countries
The process of catching up of development countries does not happen in the same way at all. It is the reverse. Because developing countries have lower wages than industrial countries, monopoly profits can be made by relacating the production of goods with a high productivity to countries with low wages. This happens everywhere in the developing world. There is no innovation behind the mechanism, which, as in developed countries, always leads to fierce competition between companies. Here the competition takes place between companies that remained in their old location (the developed world) and the new enterprises in the developing countries. Because this process is not driven by innovation, but by existing technologies, change can be swift and gigantic. China’s development ran primarily through direct investment by foreign companies. In China, Japan and Korea, all of which copied and/or imported Western technology, the process was organized, or at least orchestrated, by the state.
This process generates high profits for companies on the one hand and rapid increases in productivity on the other hand. This is possible because it does not need innovation, it is driven by geographical transfers of existing technologies instead. This creates enormous income opportunities for the poor, but not all is well – as a rule the host country refrains from taxing companies because it has to compete with other low-wage countries. If, as was the case in China during the past twenty years, productivity in the overall economy increases by almost ten percent per year and real wages (with the help of massive support from the state – in particular increases of the minimum wage) also rise while, on the other hand, wages stagnate in the rich countries, we witness global decreasing inequality, although this has actually nothing to do with the process of normal market development because, far from being a sustainable development, it is a one-off phenomenon.
The tremendous growth in China created a lot of new absolute wealth, in addition to the elimination of poverty, because the transformation was closely controlled by the state, although it was implemented by private (domestic and foreign) companies. Inequality probably increased because, although the process was planned by a communist party government, it did not dare to touch the secondary distribution to the degree that was necessary for inequality to remain unchanged.
3. The strong principle of equal distribution of income growth
The comparison of development in developing countries with the normal process of growth in industrial societies proves an important principle, which is essential to any discussion about inequality. The inequality at the micro level that constantly emerges because of Schumpeterian processes creates significant incentives to put development in motion. Here the representatives of liberalism can rightly argue that such processes should not be guided by the state nor suppressed by unions because if profits are taxed away, pioneering entrepreneurs no longer see an incentive to innovate and create monopoly profits, which, over time, spread out to the population in general (through increased productivity and higher wages). However, when you accept this position, one of the consequences is that you must also accept that wages cannot be negotiated at the level of the individual company. This has to happen, at least, at sector level for each industry or even at the macroeconomic level. Only this provides the correct microeconomic incentive. To negotiate wages at the company level, as has become the norm today, is certainly wrong, because then there is either the possibility for the employees to demand wage increases which are too high, with the consequence that other workers no longer benefit from price reductions, or wage increases can be too low, which means, in effect, that workers subsidise uncompetitive companies. Both of these possibilities destroy a functioning normal market economy.
It follows that there are no grounds at the macroeconomic level to let wages lag behind productivity gains and to allow the emergence of significant functional inequality (inequality between labour and capital). The pioneering entrepreneur will receive her or his temporary monopoly profits, even if wages fully adapt to overall economic productivity. All other justifications for general wage restraints are also untenable, as I and Friederike Spiecker explained in Das Ende der Massenarbeitslosigkeit (The End of Mass Unemployment) and in many contributions to Flassbeck-economics). There is no justification to demand wage restraint in the primary distribution and enforce it with political violence as happened in Germany, especially in the early 2000s.
Increasing inequality cannot be justified on macroeconomic grounds. It is not necessary, there is nothing good about it and it is counterproductive for growth. Indeed, people are not equal in capabilities. They are being compensated unequally. There is logic in that. However, ever increasing inequality that systematically favours higher incomes, as has happened during the last thirty years in many countries is a completely different affair. This is completely unjustifiable. Those who say that a market economy creates inequality from itself as a natural process, consciously blur the essential distinction between these two phenomena. Increasing inequality is not just a ‘consequence’ of the ‘natural’ inequality which exists between women and men. This thesis is plainly wrong and dangerous. Indeed, the contrary should be true: just because there is inequality (of capabilities), increasing inequality due to economic policy and by skewed power relations in the labour market should be strictly avoided.
You can read in the third part which economic policies are necessary and why the current debate on inequality is in many ways misleading.