A Clash of Models

Note: This post is part of our League Symposium on inequality. You can read the introductory post for the Symposium here. To see a list of all posts in the Symposium so far, click here.

Whenever I encounter a factual view (as distinct from a moral or aesthetic one) I disagree with I end up asking myself “what’s their model?”. I cannot say I truly understand our disagreement until I understand their model and how it differs from mine.

One of the significant differences in disposition between liberals and libertarians (and one of the commonalities between conservatives and libertarians) is that we are, as a rule, much less concerned about the brute fact of income inequality than liberals are.  While some of this may just be differences in preferences / morality and therefore be irreconcilable, I don’t think that’s true of the whole difference between us.

I think a lot of the difference between liberals and libertarians when it comes to our attitudes to inequality is our models of inequality. Despite caricatures to the contrary, I think most liberals object to the present levels of inequality because they think it is to a large extent the product of procedural unfairness. The disparity in incomes is evidence of the problem, rather than the problem per se. Libertarians and conservatives feel this is not necessarily the case, and are thus less concerned with inequality.

What I hope to achieve with this post is to outline my model of inequality, how I think it differs from the archetypical liberal model (while avoiding constructing a straw man, with any luck), and what that means for how I think about inequality and what I would suggest doing about it.

Let’s consider wages and salaries, the form of inequality that attracts most of the attention. How fair you think wage inequality is will depend on how you think wages are set in practice. This I think is the primary point of departure between liberals and libertarians, and I think it boils down to whether you think bargaining power or market forces is the primary determinant of wages.

The emphasis on bargaining power as a determinant of wages dates back at least to Marx’s Iron Law of Wages  The simple version of Marx’s Iron Law is that’s employers held all the cards, and thus needed to pay workers no more than subsistence wages. While just about no one holds to the Iron Law any more, more moderate versions still guide the attitudes of many on the left toward labour markets. I think the model most liberals have presumes differences in wages are to a significant extent a product of differences in bargaining power. This is certainly true of anyone who blames the increase in income inequality on the decline of unions. A bargaining power based model has three important corollaries when it comes to inequality:

1)    Rich people are rich because they are powerful, poor people are poor because they are powerless.

2)    Since wealth can increase power, point 1 can cause self-aggravating income disparities.

3)    Since the root cause of inequality is power disparity, structural solutions to inequality depend on addressing the power disparity, either through collective bargaining or through regulations to limit the power of the wealthy. I believe this is why many on the left worry are so worried about campaign finance laws.

By contrast, libertarians tend to believe more in market forces as a determinant of wages (and to be clear, this is a spectrum not a dichotomy). The theory behind this goes back to the Marginal Revolution (let it not be said that economists have no sense of humour) in the 19th Century and states that in a competitive labour market workers will be paid a rate equal to their Marginal Product of Labour, or the worth (to their employer) of one more hour of their work. The more productive you are (using this definition of productivity) the more you are paid. The logic goes that no employer will pay you more than that because they wouldn’t earn enough out of you to make hiring you worthwhile. But if you were being paid less than your marginal product of labour, another employer would have an incentive to poach you by offering slightly higher wages until in equilibrium you were being paid your marginal product of labour (this mechanism also ensures you will most likely end up employed by someone who can make the best use of your skills, since they can afford to offer you the most money).

Now before I go any further, I just want to point out something a lot of non-economists don’t understand. Productivity is not a personal virtue, it’s not a simple measure of how hard you work, your access to capital and the political institutions you live under matter a lot more than your work ethic (there’s been some interesting studies done looking at the jump in productivity Mexican workers gain when they cross into the US).

Nor for that matter is productivity supposed to be some kind of judgement of your metaphysical worth as a human being, and therefore of what you “deserve” to be paid. Economists don’t do Just Price Theorem, who deserves what is a tangled issue that can’t be resolved in an objectively satisfactory way. And since abstract socio-economic constructs can’t philosophise worth a damn, markets don’t concern themselves with theories of justice, but rather how supply matches to demand. So when I say people who are less productive get paid less, I’m not saying they are lesser people who deserve poverty, nor am I saying it’s their fault for being lazy.

As you might imagine, the corollaries from a model like this are quite different to a bargaining power model:

1)    Rich people are rich because they have marketable skills or talents, and/or have jobs where their labour is magnified by capital or some other multiplier. Poor people are poor because they lack these advantages.

2)    Structural solutions to income disparity have to come from changing the underlying economic context people operate under, such as by promoting productivity, or increasing education.

3)    Employers have every incentive to make their workers more productive, so chances are, if there are ways of doing this they will be non-obvious, difficult to implement and/or involve factors employers can’t control.

The reason I wanted to outline both models and not just the one I most closely associate with is that 1) I’m trying to understand the other side here, and to do that I need to make sure I understand their position, and 2) this isn’t a binary issue. I think we’d pretty much all agree both models have some validity, and the issue is the relative strength in each for determining wages.  And while I believe bargaining power matters, I don’t think it’s the primary driver of wage differences. I’m willing to accept that there’s some funny business with executive compensation, but the gap between the 1% and the remaining 99% would still be large and growing even in the absence of that funny business. As corporations get larger in absolute terms the difference a good executive can make matters more, and therefore executives become more productive at a faster rate than regular workers whose productivity does not necessarily grow with firm size.

So, based on my model, what should we do to address the gap between rich and poor? The key is to grow productivity, and education needs to be a big part of that. But that doesn’t just mean university, the trades are skilled jobs, and a society that doesn’t have plumbers can run into serious problems. The world is full of people who don’t take well to academic education, but can do far finer work with their hands than I’ll ever be able to manage, and we need those jobs too. Our shared culture has a long history of treating white collar work as though it was better somehow than blue collar and that needs to end. To do well in the modern world you need marketable skills, and there’s nothing wrong with getting those from a vocational school of some kind, or even an apprenticeship. The wealth of nations derives from specialisation and trade, homogeneity weakens us.

Regulation I think is also an obstacle, both because it lowers productivity through compliance costs and it increases barriers to entry, which increases the bargaining power of employers  That’s not to say simply eliminating all regulations is a good move, each regulation is its own unique and special snowflake. Some areas are properly regulated, others need to be regulated, but in less compliance-heavy or distortionary ways. Hell, some areas may need more regulation. All I’m really saying is that the regulatory burden needs to be given a rational review on a regulation-by-regulation basis. Particularly regulations that impose licensure requirements or limit entry through “needs assessments”, as these are more often than not simply cash grabs on the part of incumbent producers.

However, it’s worth noting that these measures won’t necessarily be sufficient to decrease inequality to historical levels. I believe that the growth in inequality is driven by changing economic fundamentals that cannot be reversed. This is one reason why I support welfare for indigent people; there will be some people whose productivity in the current economy cannot yield a sufficient income to sustain them.  This may not be fair, but its unfairness doesn’t automatically imply a solution.

So, to summarise this bloated mass of a post into a few bullet points, here is what I think you should take away from this post about inequality:

1) There are actual economic reasons inequality is growing, which can’t be reversed.

2) This is not to say the reasons are fair, but the mere fact something is unfair doesn’t imply any particular solution, or even that a solution exists.

3)  If we are to raise the standard of living of the poor, increasing their productivity will have to do most of the work.

4) Increasing the productivity of the poor is really hard, so don’t count on making a lot of progress.

5)  Regulation can (and often does) make it harder for workers to get a fair deal out of their employers.  Some combination of deregulation and different regulation may improve matters.