Distribution of Income By The Plutocracy

I’ve written a pair of posts at Naked Capitalism on the neoclassical theory of marginal productivity as an explanation for the distribution of income in our neoliberal market economy. The first is based on Thomas Piketty’s Capital in the Twenty-First Century, and examines the bloated pay of top management. The second focuses on pay for the rest of us, based on the discussion of Paul Samuelson and William Nordhaus in their introductory textbook Economics (2005 ed.).

The second post points out that John Bates Clark, who dreamed up this theory around 1900, said that it is based on the natural law. In other words, the distributions it supports are morally just. People want to believe the “market” pays them fairly, and the theory comports with the Invisible Hand mumbo-jumbo they also believe, so they buy into it despite overwhelming evidence to the contrary, including their own experience. Both posts suggest an alternative hypothesis, that incomes are distributed on the basis of power. So one good question might be: what is the basis for rewarding capital?

Here’s a brief description of the theory of marginal productivity advanced by Samuelson and Nordhaus, from the second link

… [T]hey define Marginal Revenue Product as the additional revenue produced by a unit of input of something (labor, steel, electricity, cash loans) while all other things are held constant. It is equal to the marginal revenue the firm gets from the sale of the additional output, if any, created by the additional unit. Hands are waved, and the authors tell us that the firm should add inputs of all kinds to the point that the marginal revenue product of the input is less than or equal to the cost of the input. Here’s a chart, Samuelson/Nordhaus at 238.
S:N Marginal Product Graph 2
The authors explain that the rent triangle is equal to about 1/4 of wages, which “… reflects the fact that labor earnings constitute about three-quarters of national income.” Nice and simple. So then we calculate the supply and demand for the entire economy by adding up all the supply and demand curves of every firm. Then we have equilibrium at the point where the supply equals the demand. From here, it’s a short step to determining the distribution of money to wages. Samuelson and Nordhaus give us the model of John Bates Clark from 1900.

Clark reasoned as follows: A first worker has a large marginal product because there is so much land to work with. Worker 2 has a slightly smaller marginal product. But the two workers are alike, so they must get exactly the same wage. The puzzle is, which wage? The MP (marginal production) of worker 1, or that of worker 2, or the average of the two?

Under perfect competition, the answer is clear: Landlords will not hire a worker if the market wage exceeds that worker’s marginal product. So competition will ensure that all the workers receive a wage rate equal to the marginal product of the lat worker.

But now there is a surplus of total output over the wage bill because earlier workers have higher MPs than the last worker. What happens to the excess MPs…? The rest stays with the landlords as their residual earnings, which we will later call rent. Why…? The reason is that each landlord is a participant in the competitive market for land and rents the land for its best price. 237-8, emphasis in original.

John Bates Clark was one of the important neoclassical economists. This is from a recent paper.

Clark is best known for his marginal productivity theory of distribution, which famously says that “the distribution of the income of society is controlled by a natural law, and that this law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates”. Labor’s wage, which Clark interchangeably calls “standard,” “normal,” “natural,” and “competitive,” is thus determined by the value of its marginal product (what Clark ordinarily terms “specific product”). Fn and refs. omitted.

Most of the rest of both posts is devoted to showing that the evidence doesn’t support this armchair speculation. Evidence is irrelevant, of course. People don’t want to believe they are being cheated by the capitalist system or by the rich, because that would violate their Secular Religion, US Constitutional Capitalism, to which all has capitulated, including their religious belief system and their belief in the rule of law and the Bill of Rights and so on. If people really thought that Constitutional Capitalism was totally corrupt, they might have to do something about it.

The explanation offered by Samuelson and Nordhaus for income distribution is worth another look. Here’s the caption in the text:

Each vertical slice represents the marginal product of that unit of labor. Total national output ODES is found by adding all the vertical slices of MP up to the total supply of labor at S.


The distribution of output is determined by marginal product principles. Total wages are the lower rectangle (equal to the wage rate ON times the quantity of labor OS). Land rents get the residual upper triangle NDE. 238.)

So, this chart is supposed to represent an entire societ. The wage portion is the wages that go to everyone from wildly overpaid CEO to the minimum wage home health care worker. That means it hides all of the changes among wage-earners. As this paper by Larry Mishel shows, that rectangle hides a huge change in allocation between the top earners and the rest of us. We are all familiar with charts like this one by Mishel:

Click to enlarge.

Click to enlarge.

He estimates that about half of the gap between productivity and wages is accounted for by increases in incomes at the very top. That’s a convincing demonstration that power is the determinative issue in income distribution, not anything to do with “markets” or natural law. And it gives a clear idea of how much is hidden in the lower rectangle.

Now take another look at that Samuelson and Nordhaus chart. They say that the money in the triangle DEN belongs to landowners, as “rent”. Of course, since this is about the entire economy, it must be that this “land” is actually all capital, machines, factories, and natural resources, to the extent they are owned by some specific human being or Corporate Person. So why exactly does all of what the authors call excess marginal product go to the capitalists? “The reason is that each landlord is a participant in the competitive market for land and rents the land for its best price.” That doesn’t sound like a reason to me. It sounds like a pre-ordained conclusion.

In fact, as Mishel shows, the last 35 years have seen a reallocation of income between labor and capital. Mishel estimates that about 20% of the gap between productivity and wages is accounted for by increases in the share of national income going to capital. The balance is accounted for by faster increases in prices for goods purchased by consumers compared the prices of things they produce. Mishel calls this the “terms of trade”, and it accounts for a significant part of the variance. Mishel suggests that the gap may mean that higher productivity is not improving overall standards of living, and that further research is needed. I’d suggest that this gap ultimately goes to the capital owners and their highest paid employees.

We’re told this is all for the good, either on natural law grounds or because it’s efficient. The natural law thing is nothing but a veneer of philosophy over the greed of rich patrons. Efficiency is currently structured to prioritize the rich over the rest of us. As Mishel shows, the rich, both capitalists and top earners, are taking all of the gains from increased productivity for themselves, money that used to be distributed across the income spectrum. Why should I care at all about efficiency if the burdens fall on my back and the benefits all flow to a tiny number of Capitalist Aristos?

10 replies
  1. Rayne says:

    IMO, some distortions in economic perspective are bound up in the shift to a knowledge economy combined with offshoring labor to locations with even cheaper fungibles. In other words, there’s been a change in the definition of capital to include knowledge, but it’s not recognized by the beneficiaries of the old manufacturing economy.

    Over the last 20-30 years, the former landowning class has transferred some of its operating costs — specifically training, now realized as secondary education — to employees. Where on-the-job training was far more common in a manufacturing society, it’s not done in a knowledge economy. Workers are expected to arrive with a baseline knowledge, and only a minimum of additional training is expected as an expense. Education is not just an expense, however; the aristos in many cases have no business model without reliance upon this factor of production, just as they might without plant or office space. They also frequently expect their knowledge workers to come prepared with their own equipment in the form of computing and communications technology.

    Employees once could expect to command more pay if better and competitively educated — rent for the monies invested in education, plus pay for their labor. But over the last 15-20 years, rising education costs combined with iffy labor demand meant college education could be a gamble in terms of returns. (Risk itself suggests these employees are not pure labor, but in a class between the aristo-entrepreneurs, and the uneducated labor force.)

    At the same time, the former-landowner-class aristos have continued to make profits while specifying and demanding increasingly stringent education from their labor force.

    I think there’s some suppression of new entrants into business as well, possibly thwarted by same aristos buying regulation that favors them, but I need to do more homework on this.

    • Francine Fein says:

      Rayne, interesting to seethe term “knowledge economy” — years ago (70s) I worked for Herman Miller Research and the leader of that group, Bob Propst, an amazing man, used to talk about “knowledge workers” — it was a new term to me — and at the time, to everybody else. He was light years ahead of most folks.

      Being in the software biz, I always enjoy your blogs. Hope 2015 is a good year for you.

  2. bloopie2 says:

    Well, I don’t know who is your intended audience, but I sure feel dumb. I can’t follow you when you take down a bunch of economists so easily and quickly; you must be really, really good to be able to do that. But I sure like the part where you say, “People don’t want to believe they are being cheated by the capitalist system or by the rich, because that would violate their Secular Religion, US Constitutional Capitalism, to which all has capitulated, including their religious belief system and their belief in the rule of law and the Bill of Rights and so on. If people really thought that Constitutional Capitalism was totally corrupt, they might have to do something about it.” I can understand that stuff; no one needs to know anything to believe that stuff.

  3. Alan says:

    I’m jumping in here late as I didn’t get to read your earlier posts on neoliberalism until after the comments were closed. I want to problematize some of the discussion.

    I think the term neoliberal can be problematic as it serves lots of different purposes depending on the user. See Terry Flew’s Six Theories of Neoliberalism.

    A not insignificant problem in your earlier post is that you gloss over liberalism between Locke and the New Deal. In The Neoliberal Inhabitants of Mont Pelerin You wrote “The point of the MPS is to preserve and extend classical liberalism”. But which classical liberalism? You make reference to Locke but the Mont Pelerin Society was primarily focused on economic liberalism and usually linked their thinking back to Adam Smith and other liberal economic thinkers (but see below). There are lots of differences between those thinkers and also between those thinkers and people who are often classified as neoliberals. Even within the MPS there were significant differences between members and even the thinking of individual members over time ( e.g. Milton Friedman).

    Mirowski’s book is interesting as a catalog of the contradictions and fairy-tales of modern political economy but it is also an attack on the failings of the critics of neoclassical economics and neoliberalism. In his words, “the left has been the author of it’s own rout”. I took part of his point to be that the left hasn’t really done the work necessary to mount a coherent challange. There are lessons to be learnt from the MPS. Hayek was building a network of intellectuals and think-tanks knowing full well that it might take decades to gain traction (and he supposedly took this lesson in turn from the Fabians). For histories see Angus Burgin’s The Great Persuasion: Reinventing Free Markets since the Depression and Daniel Stedman Jones’s Masters of the Universe: Hayek, Friedman, and the Birth of Neoliberal Politics.

    A lot of people, including Mirowski, reference Foucault’s analysis of neoliberalism. (But see Flew’s discussion referenced above for a critque of some interpretations of Foucault.) Mirowski and others, such as Bernard Harcourt, have important criticisms and reworkings of Foucault writings on neoliberalism. Foucault’s history and facts tend to be somewhat unreliable but his his way of thinking about power and subjectification that are revealing. His lectures on neoliberalism are a critique of Marxist and statist theories of power. (Note that Foucault’s relationship to neoliberalism is currently the topic of lively debate.)

    You reference “Invisible Hand mumbo-jumbo” in the post above. Many neoclassical economists and neoliberals (and often their critics) link the concept of an invisible hand back to Adam Smith. This is a legitimizing mythology. There is no theory of the invisible hand in The Wealth of Nations or any of Smith’s writings. And a convincing case could be made that there are substantial differences between Smith’s ideas and those of Hayek, Friedman, et al. I think it is important to understand how they decontextualize Smith, selectively use and interpret his writings, and appropriate them for their own ends. I doubt Smith would have much truck with Friedman’s market utopianism or the man as a rational utility maximizer. And there’s the irony. A key motivation for the MPS was opposition to what they perceived as spreading totalitarianism but their own conception of a reformed market liberalism has at its core a totalizing and impoverished subjectivism.

    • Ed Walker says:

      Thanks for your review of some of the crucial issues around neoliberalism. I don’t think of neoliberalism as a creedal theory, with a catalog of required beliefs; rather as a set of programs which are pursued by a reasonably coherent group of people. Thus, I refer to Mirowski’s description. As you say, one of the crucial issue to the MPS was the fear of socialism or Communism. That fear was shared by a group of rich people who hated FDR, the progressives of an earlier era, and John Maynard Keynes. They barely tolerated democracy, and only because it was opposed to Communist Russia. They funded Hayek and the University of Chicago schools of business and economics solely to further their own agenda of restoration of the rights of the rich. That same fear runs deep in the political circus today.

      The sole basis for affirming Hayek and later Friedman and others is that they provide intellectual cover for the entire program of the right-wingers.

      The point of this and my related posts here, at Naked Capitalism, and at Firedoglake (here’s my author page: http://firedoglake.com/author/masaccio/), is that these ideas have infected the public discourse to the point that liberals have no alternative to put forward. Following C. Wright Mills, I think that the US left, including especially its academic and intellectual sectors, capitulated to the Capitalist Celebration. That’s why we see decades of erosion of the New Deal laws, and more important, the underpinnings of those laws, which is that government can and should be a tool to make life better for average citizens.

      There are alternatives to neoliberalism, but no one takes them seriously because they conflict with the ideas drummed into us from our earliest days and reinforced in Econ 101 and 102 for those of us lucky enough to go to college. The first step to change is to get people to understand that Samuelson and Nordhaus and their ilk are teaching “highly ideological speculation” suffused with mathematical conjuring. That’s probably why Piketty has such a big following on the leftish side: he talks about theories derived from data, rather than theories dreamed up by people suffering from physics envy.

  4. emptywheel says:

    Well timed post, given that wages fell last month in spite of a lot of new jobs (which will probably disappear once they’ve sorted out the Christmas hires). In the debate that has ensued, it’s clear people forget just how high 6% unemployment still is, or what the effects of increasing splits in unemployment for the educated and not (see also Rayne’s comment).

  5. wallace says:

    quote”As Mishel shows, the rich, both capitalists and top earners, are taking all of the gains from increased productivity for themselves, money that used to be distributed across the income spectrum.”unquote

    hmmm, I’ll pass that on to the Ghosts of Tom Joad. I’m sure they’ll be shocked.

    note to self..file this under


  6. x174 says:

    great and much needed (historical) analysis of the foundations of American capitalism.

    from my research, the natural law rationale is a conflation of Adam Smith’s “invisible hand” (read ruthless exploitation) Spencer’s racist re-interpretation of Darwinian evolutionary theory popularized for businessmen (Veblen’s usage) as Social Darwinism, whose best promoter was William Graham Sumner, who strongly believed that showing consideration of any sort to those destroyed by the Industrial Revolution are unworthy of our attention.

    the fun part comes in when financial panics occur and the banks need to be bailed out b/c, apparently, survival of the fittest only matters when its convenient for them. you know, business principles.

    look forward to reading more of your work. thanks.

  7. earlofhuntingdon says:

    Nicely done. Thanks.

    1900 would put Bates Clark within the first era of Social Darwinism, described as neither social nor Darwinian, but rather as a misappropriation of the language of popular science, used to justify an economic elite’s rapacity and selfishness. Claiming something as “natural” – whether fruit juice, yogurt-flavored sugar, or economic disparities – helps to isolate a topic from discussion of its morality, causation and doing something about it. Along with passivity and social atomization, it cements the status quo, which American economics seems to have made its prime directive.

    As for the god of efficiency, efficiency for whom, toward what ends and by what means? Funny how efficiency is taught as the be all and end all, as if it were the lynchpin of moral, religious and civil society rather than an after-the-fact justification. Economic elites are socially minded enough when it comes to aiding their families, friends and peers, whereas giving similar aid or acting with restraint to those outside their narrow circle is considered reprehensible because “inefficient”.

  8. Alan says:

    x174 “…conflation of Adam Smith’s “invisible hand” (read ruthless exploitation)…”

    Smith is quite critical of ‘ruthless exploitation’ and certainly doesn’t provide a rationale for greed and selfishness as he is often misrepresented as doing. Wealth is an attack on mercantilism. A prime example in the book is the British East India Company, the ruthless global corporation of his day.

    And as I stated about there is no theory or concept of the invisible hand in any of his writings. The phrase appears exactly once in Wealth and is used as a metaphor. Smith is no believer in the magic of self-interest. He’s not an ideologue like Friedman and others Ed is criticizing. There are plenty of examples in Wealth in which Smith points out examples in which the pursuit of self-interest has deleterious social effects and he argues the need for regulation. As Ed points out above, you’d never know this from reading Samuelson or studying economics at most colleges and universities today.

    In fact, I believe that the history of economic thought is taught in history departments but has been systematically exterminated from the curricula of economics departments. This goes along with the conceit that economics, unlike other social sciences, is a true science like physics (Mirowski writes about this as well).

    Anyway, my larger point is that if you take modern economists to frame what Smith said (and others) to fit their own agenda, you’ve already given away the Enlightenment and lost the war.

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