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Economics Can’t Explain Why Inequality Decreases

15.09/2019

A problem with Piketty’s explanation

In September I went to an international conference in Vienna, Austria, The Haves and the Have Nots: Exploring the Global History of Wealth and Income Inequality. One thing I learned at the conference is that, apparently, economists don’t really know why inequality increases and decreases. Especially, why it decreases. 


Let’s start with Thomas Piketty, since Capital in the Twenty First Century is currently the “bible” (or should I say “Das Kapital”?) of inequality scholars. 

Piketty provides a good explanation of why inequality increases. It’s good not in the sense that everybody agrees with it, but in the sense of being good science: a general mechanism that is supported by mathematics and by data.

So far so good. But how does Piketty explain the decline of inequality during the middle of the twentieth century? It was a result of unique circumstances—two destructive world wars and the Great Depression. In other words, and forgive me for crudeness, shit happens. 

This is not a particularly satisfactory conclusion. Of course, it’s possible that the general trend of inequality is always up, except for random exogenous events that knock it down once in a while. So devastating wars destroy property, and by making the wealthy poorer reduce inequality. This is one of the inequality-reducing forces that Piketty mentions several times in his book.

To me such exogenous explanations are not satisfactory. My intuition (which I understand may not be shared by all) is that when inequality gets too high, there are forces that bring it down. In other words, to some degree it’s a regulatory process, and that’s why we don’t see truly extreme forms of inequality (when one person owns everything). In Piketty’s view, the only reason we don’t see such extremes is because some kind of random event always intervenes before we get to it.

In his talk Branko Milanovic addressed the question of what brings down inequality. As he must – if inequality indeed moves in cycles, as he proposed, then there has to be some endogenous process that is triggered when inequality gets too high, and brings it down. Periodic operation of such a mechanism is what would generate repeated cycles.

Branko admitted that “malign” forces that could bring down inequality are not well-studied. As to “benign” ones, he cited three that fall under the acronym TOP: technology, globalization, policy. The only one that makes sense to me is policy—indeed, governments can reduce inequality by taxing high income and wealth. As to the first two, technology and globalization, I think that they rather explain why inequality increases.

In a later talk, Walter Scheidel addressed the “malign” forces. Walter is working on a book with a tentative title The Great Leveler, in which he identified four forces that have reduced inequality in historical societies:

  • Mass mobilization warfare 
  • Transformative revolution 
  • State collapse 
  • Pandemics 

Note that all of them are “malign”, because they all involve violence. So violence is the great leveler. But of course some forms of violence result in increased inequality. Take war. Many conquest wars, for example those in which a band of warriors conquers egalitarian farmers, turns them into serfs, and sets the victors up as the ruling class — such wars obviously result in increased inequality.

This is why Walter focuses on mass-mobilization warfare. Societies that are forced to mobilize all citizens capable of bearing arms (or, at least, all males) are usually—always?—forced to reduce inequality. Same thing with revolutions—not all of them reduce inequality. Some simply exchange one set of oppressive elites for another. But others do level the wealth quite dramatically.

I think Walter is on to something, and his theory can be made endogenous. That is, when inequality becomes too high, the chance of a state collapse or transformative revolution increases. Alternatively, or additionally, hugely unequal societies are defeated by more equal ones, which either eliminates them, or forces them to reduce inequality to rise up to this existential challenge.

In my view, Walter’s theory captures something important, but it is incomplete in two ways. First, we need a better understanding of why violence in some situations increases inequality and in others decreases it. Second, I think there are mechanisms other than violence that can reduce inequality. However, I am not very sure of this. Perhaps it’s just the optimist in me that wants to believe it.

As a way of concluding, what does it tell us about economics’ capacity to explain the dynamics of inequality? In my opinion, economics is perfectly capable of explaining why inequality increases, but fails to do so for inequality decreases, because they are a result of extra-economic forces. So if we want to understand how historical societies reduced inequality, we need to go beyond economics and bring insights from history, sociology, and anthropology.

And I certainly hope that we can figure out how to reduce inequality without violence.

Originally published at Cliodynamica on 1 November 2015

Source: Evonomics