I initially undertook this research due to my frustration when looking for information about tax and income inequality while working at Infometrics as an economist.  The 1980s and 1990s had seen dramatic changes taxes and payments to beneficiaries, and also to income inequality, so I thought it would be a valuable contribution to tease out how much these changes in tax and benefit settings had influenced income inequality in New Zealand.

To do this I worked with the models available at the New Zealand Treasury and Victoria’s Chair of Public Finance to calculate the payments that would have been received by someone in the early 2010s if taxes and benefits (including superannuation) were the same as they were in the late 1980s and early 1990s (adjusting these figures up for wage growth over that time). 

In other words, if New Zealand had not change the tax and benefit system and had instead increased payments at the same rate as wages since the late 1980s what would income inequality have looked like?

Analysing this information, and considering what would have happened in reverse – if current settings were applied in the late 1980s and early 1990s – I found that nearly 46% of the increase in income inequality appeared to be due to these changes in taxes and benefits.

However, this ignores the way that the change in taxes may have changed people’s behaviour – the new tax settings may have seen them work more, invest more in education, migrate to another country, change when they move out of home, or any of a myriad of other changes. 

As a result, I corrected the figure for the change in the way people worked due to policy.  This reduced my figure, suggesting that just over 39% of the increase in income inequality was due to the tax and benefit changes.

These things are hard as it involves trying to find a balance between accuracy and clarity – when there can be a trade-off.

“Transfers” is a more accurate term than benefits, given that a number of the payments are not seen as benefits (eg national superannuation), and the inequality number is disposable income inequality – the number after taxes and transfers. But I’ve also been told that these two terms get people stuck and make it hard for people to make sense of what is going on when trying to understand the result.

Also how do we discuss the shortcomings without overplaying them? There is a lot missing (how have some of the other characteristics of the population changed due to policy – how are these related to some other results in my thesis?), but given that the core of the result is itself of interest. This point estimate of 39% needs to clearly have uncertainty around it – but that uncertainty doesn’t imply its irrelevant.

Anyway, I’m not particularly good at research of communication – so trying to do both is a learning experience. Would be interested to here your thoughts about whether I’ve made appropriate choices about this trade-off, or in questions you may have about the research!

This is the question of factor income shares.

An income share for a broad category like “labour” or “capital” will depend on two things – what happens with the quantity of the factor and what happens with the price of the factor.  If we have more labour for the same amount of capital it will imply that labour’s income share must rise.  However, as the marginal product of labour will decline in that case it is likely that labour’s price – the wage – will decline.  

As a result, it is unclear whether a higher quantity of labour (or capital) leads to a higher share of income for that factor.

In this context, we can start of by thinking about a constant elasticity of substitution (CES) framework – where production function has a constant change in factor shares (e.g. capital and labour). In this case, if the amount of capital rises then the relative return to capital falls (with an increase in wages or reduction in the rate of return to capital) such that the relative income share of labour and capital changes by less than the increase in the quantity shares.

This makes a lot of sense.  More capital makes labour more productive, by providing more tools to do the work. However, capital can also be used to do some tasks that labour could also perform.  For a given technology, the only way for it to make sense to change that mix would be if capital was to become relatively cheaper.

Following Piketty’s Capital it has been made clear that the nature of these changes matters. Both because the income shares themselves matter because of the difference in the distribution of the factors among individuals.  Also because the nature of the change (do rates of return decline, or do wages rate) matter in terms of the livelihoods of people.

In this post I want to briefly describe three scenarios and what do they mean from economic perspective. The scenarios are 

1. When CES is equal to 1;
2. CES is less than 1 (complementarity);
3. CES is greater than 1 (substitutability).

What happens when CES is equal to 1

In this case if the amount of capital rises, then the relative return to capital falls (with an increase in wages or reduction in the rate of return to capital) such that the relative income share of labour and capital remains unchanged.

The use of these functions stem from the Kaldor Facts – stylised facts that were used to describe macroeconomic statistics in the past.  

However, we know that this CES form doesn’t have to hold in reality – and so want to think about other forms.

What happens when CES is less than 1

This is the case that has, globally and historically, been most likely to hold in aggregate.

Here we state that labour and capital are considered to complement each other – at an extreme this can be though of in terms of a Leontief production function.

In this case increase in the capital stock will increase the relative share of income that is earned by labour. The simplest way to explain this result would be to think about how the change influences each price – the increase in capital leads to a large decline in the marginal product of capital as labour is fixed (in the extreme Leontiff case, the MPk = 0 past the current labour input), while the increase in capital lifts the marginal product of labour.

The vast majority of literature suggests that labour-capital income substitution is below 1 and the assumptions that capital-augmenting technology would raise the labour share is drawn around that assumption.

What happens when the substitution is above 1?

This is the case when labour and capital instead shift towards becoming perfect substitutes. Here an increase in the quantity of capital does less to increase the marginal product of labour and/or has less of an impact on reducing the marginal product of capital for a fixed amount of labour.  As a result, there is less downward pressure on rates of return and less upward pressure on wages. Overall, an increase in the quantity of capital will lead to an increased income share for capital.

Thomas Piketty in his book Capital suggests that elasticity of substitution for some nations is above 1, and in the case of France and Spain this appears to be the case. However, estimates for the US and a number of other countries have not shown this form.

This all leads to the question – how does New Zealand stack up? 

What is the New Zealand evidence?

The NZ evidence shows that labour-capital elasticity differs across sectors and industries, with both Stats NZ and RBNZ working papers indicating significant variation by industry.  

However, both papers also give us different results for the aggregate elasticity – with the Stats NZ paper suggesting a figure that is less than 1 while the RBNZ paper indicates a figure that is greater than 1.

Understanding what the true elasticity of substitution is in the New Zealand context – and how technological change may influence it – seems like an important question to get a definitive answer on!

Just wanted to say thanks! If it wasn’t for the active discussion here and the passionate New Zealand economics community I would never have done it.

You can find a version of it here (and the archive here). And working paper versions of a number of the chapters:

• on NZ tax-transfer history,
• Vertical and Horizontal equity,
• imputing wages for those who aren’t working,
• estimating labour supply responses to changes in available net incomes,
• and decomposing changes in income inequality into tax and non-tax components.

I had meant to do posts on the issues here, but only really found time to write about the inequality measure I mainly used (the Gini coefficient) and a post on measuring vertical and horizontal equity.

Next year I will be back adding up some material from teaching 1st year economics at Victoria University of Wellington – I’ve been teaching the introductory micro and macro courses for a few years now as a teaching assistant, and will keep it going while I also do other work (as I love it).

My concern four years ago was that the non-rationalist identity politics of the left would open this type of negative nationalistic politics on the right – or would at least be used as a foil for it.  The refusal to actually state our assumptions and values is a failure irrespective of the intentions we hold.  In that way, when exploring Youtube I’ve been pleasantly surprised by the leftist video blogs – and their willingness to fully articulate their views.  Key examples of this are Shaun, Contrapoints, and Philosophy Tube.

However, these channels are distinctly “anti-capitalist” in terms of wanting sizable change in the status quo.  I am a mainstream economist that believes in incremental change.  A full discussion of this would be interesting – but give me time.  But to do so we need to get something clear about the labour theory of value that I am hearing them describe – it doesn’t make sense as a justification for anything let alone as a “theory of value”.

Note: The actual labour theory of value has been defined many ways – and the most profitable Marxian interpretation I’ve seen is trying to understand LTV as part of a subsistance wage argument on factor income shares.  That isn’t the focus here.

Here is the theory being used recently on Philosophy Tube [Note: In his Marx video he says there is debate about it … but I was of the impression that Marxists didn’t rely on the specific assumption articulated here, and economists have would not find this particularly useful for description or as having normative significance – after all Joan Robinson did call the whole LTV tautological and a silly verbal game, and she is one of the most historically left leaning people in the economics discipline].

So without labour it does not matter how much capital we have nothing is produced.  Therefore all “profit” is generated by labour and is labour value that is extracted by capitalists.

Now that first premise is true isn’t it?  Without labour, capital produces nothing!  This is indeed an assumption I teach early in stage 1 economics, and the production process in most firms shows this to be very true.  Take the example of a lawnmowing business – if we have a lawnmower but no-one to operate it we can’t mow lawns.  Furthermore, buying another lawnmower won’t “increase” output, as we still have no-one to actually do it!  This is textbook true.

But lets flip the script.  Suppose you have hired a bunch of people to work for several hours for your lawnmower business, but:

1. You provide them no lawnmower [physical capital – or the tools used by labour which increase their output]
2. You provide no fuel for a potential lawnmower [other inputs]
3. You provide no information about where lawns need to be mowed [coordination services]
4. You have no connection to the demand for lawnmowing services [entreprenuership]
5. The labourers have no knowledge or skills that make them able to mow a lawn [human capital]

Well in that case no matter how many people you hire you get no output!  Wait a second … does this mean that all the value of production is embedded in one of these other inputs!!!  No, no, no.

Could it instead be that all factors of production codetermine output.  Furthermore, these factors require a minimum return in order to be supplied, where these rates of return/ prices are termed “profit” and “wages”?  Doesn’t this make it a collaborative process rather than extractive?  [Protip:  It can be both collaborative and extractive – but we need to model why rather than just positing it is ]

The production process

Production is a process of coordination between factors of production – that is why in macroeconomics we have a firm (the thing that combines factors of production to create output) and households (the group that buys output, but also supplies all the different factors of production to the firm – yes including capital, capital owners are “households”).  In macro we refer to these varying incentives (the incentive to supply factors of production to purchase consumption over time, and the incentive to supply output in order to “get profit”).

Yes it is true, labour does not receive the entire surplus from production.  But they don’t supply the only factor of production either – so I am uncertain why they should.  Production is a joint process which creates surplus value – and this surplus value is then shared according to the bargaining power of participants.  Inequity is then a process of insufficient bargaining power – not a natural consequence of private capital.

Much economics treats other factors as fixed and labour as variable.  Typical descriptions of the labour theory of value also look at a “fixed production process” such that additions to labour explain the entire addition to output.  Furthermore, there is an opportunity cost associated with every single input – labour is sacrificing alternative uses of their time, capital owners could liquidate assets to fund consumption or alternative investments.  Each has an opportunity cost, and is undertaking a process that creates surplus value – we need to ask about the relative bargaining power (which then determines the price here, the real wage) in order to ask how this is split.

Or to put it another way, there is a stock of labour and a flow of labour provision (hours of work) which is remunerated with wages, there is a stock of physical and coordination capital and a flow of related business services (the use of capital hours, “effective” entrepreneurial labour by capital owners) which is remunerated through profits.  Those utilising capital may need to borrow in some way (selling shares, borrowing from a bank) to put this in place which then changes the allocation of these profits sure – but is still predicated on the provision of this flow of services.

So given that economists often treat the level of capital as if it is fixed and provided in the moment (a similar assumption to the one we make for land – and one that is not necessarily appropriate in many instances), if we want a theory of price determination looking at the “labour embodied in a production process” appeared to be a way to get there.  This Ricardian view wasn’t saying that labour was solely responsible for production – this is a semantic point that gets lost!

In the end this left some problems though – why is a painting that ages with no additional labour input more expensive than when it was initially painted?  The solution to this appeared to be adding “use value” which in turn begs the question why is water free while diamonds are so expensive?  In the end marginalism, with price set in relation to the marginal cost of production and the marginal use value/utility of consumption solved both of these!  With labour is often treated as the variable factor, the marginal cost is often stated as the marginal cost of labour – and thereby wages being set relative to the marginal product of labour became a description for labour markets as well.

We can go too far with this as well.  We may say that any urge to change this “natural” wage by increasing labour’s bargaining power will reduce employment and output/surplus value in the industry.  Of course this ignores two things (assuming it is descriptively accurate of firm-employee behaviour in the long-run):

1. There can be bargaining power the other way – monopsony matters.
2. Just because this describes prices doesn’t tell us that labour is receiving their contribution to the process [we might think of this in terms of the average product of labour IF we could define a portion of production that is attributable to labour]

That last bit makes the issue of distribution bloody difficult – and the idea that we can rely on marginal products for considering a fair income distribution is NOT mainstream economics.

At this point the relation between this and income shares must become sort of clear – so let me just point out the posts we’ve done on classical, Marxian, Neo-classical, Marshallian, Post-Keynesian, Neo-Ricardian, and General Equilibrium factor shares here.  Given the complication of discussing such shares I note:

It is for this reason I strictly favour analysis of household level data for discussing points on distribution, rather than analysis of factor shares.  If I was to build up larger “groups” than households to discuss, I can tie them together on shared characteristics in this framework – compared to the arbitrary and loaded combinations of “parts of individuals” that occur with factor work.

A big point here is also prices in goods markets.  If returns to labour AND capital are equal to their opportunity cost then we know that prices will be set in a way that “maximises surplus” from the production process.  This is nice.  Now if that process leads to very low labour income WHEN those things are occurring, the implied labour value must be low in that process – that is fine.  This doesn’t need to imply that incomes must be low – instead it describes a specific income generating process, and would suggest to many people that we should find a way of supporting individuals with a low opportunity to earn income.

Now, if we were in a situation where labour and capital were only earning their opportunity cost I doubt the return to most labour would be that low – but there would be industries, and individuals with issues that limit their income earning capabilities, where that may be the case.  I think, perhaps, the focus can then be on:

1. Competition in goods markets
2. Competition in factor markets (specifically labour markets)
3. The opportunities and income adequacy of the worst off.

There are a lot of clear functional injustices in these places – why do we need to use a nonsensical “theory of value” to complain about the return to labour?

Conclusion

Left Youtube seems to view the idea that “all surplus is generated by labour” as true – and by association “all surplus should go to labour”.  They term this the “labour theory of value” and use it in a normative sense.  However, it makes no sense to use the labour theory this way, especially once we start thinking about other factors of production and how they are chosen.

The reason this narrative is used is because they seem to disagree with the idea of private capital, and they want to see fundamental injustices as due to the private nature of capital.  However, applying a standard supply-demand framework allows us to see that there is potential for piles of injustices out there that have nothing to do with the ownership structure of capital – instead there are clear power imbalances, power imbalances that can be identified and “solved” if they exist.

There is no need to dismantle current ownership and governmental structures – but there is need to think about fairness and distribution more clearly using the economics tools we already have

Equity.  Is the word economists unjustifiably confuse with fairness in order to pay lip service to distributional concerns

Ok I’m being a bit of a dork – in all fairness equity is a good start in asking these questions, but we have to see these measures as only a start!

At the most basic level, when we think about output/income and its distribution in society we consider the average of the income distribution (the mean) and its dispersion (the variance).  If incomes are rising over time as they have been for 200 years, then the variance also rises so we normalise such measures.  This is where inequality measures like the Gini coefficient come from.

The idea of (income) equity goes a step further than just describing the general distribution of income – it considers what happens when we impose an external policy that changes that distribution.  It measures a couple of principles that we may – or may not – value when applying a policy that changes the distribution of income:

1. Vertical equity:  Captures the proportionality of the system applied – if we introduce taxes are people with higher initial incomes paying proportionally more, if we introduce transfer payments are people with lower initial incomes receiving proportionally more?
2. Horizontal equity:  When we have two individuals we see as “equals” does this policy system treat them the same way?

With taxes and transfers these measures involve comparing the way people are treated by the tax-transfer system based on a view on what constitutes “equals”.  Specifically, these two concept can only fit together without conflict when looking at income if equals are defined as people with the same income.

Now in this post I will concentrate only on Vertical Equity – we can do Horizontal Equity another time!  And in line with my desire to be a bit more useful I want to focus on how we might measure these concepts, and what we are assuming when we do.

Wait, what is vertical equity?

Vertical Equity (VE) is the idea that those with greater access to resources SHOULD pay PROPORTIONALLY more – not just more, but more as a percentage of their income.  You may personally agree or disagree, that is fine, that is just what it is.

Given that idea, there is a certain level of proportionality that is desired – so there is some optimal level of VE, which could be higher or lower than it is.  Again, this is a value statement so I just leave that as is.

The key take away is that VE is a measure of the proportionality of the tax-transfer system, and we don’t necessarily want more or less VE – we need to come up with a set of values that articulates how much VE we believe is appropriate.

Now we need to figure out how to measure this concept assuming that we can boil everything down to income!

Stop.  You can calculate a Gini coefficient for pre-tax and transfer income and post-tax and transfer income and just look at the difference.  Why complicate matters.

Look I feel you random comment – but things are never that simple.

Let us put Horizontal Equity (HE) to the side for now, as it is an epic can of worms.  Instead, let’s think about Vertical Equity (VE) and fairness.

At face value we are taking proportionally more from those with more and giving proportionally more to those with less, it sounds perfectly fair.  But lets do a thought experiment regarding this idea to see how – even before asking about family structure and differences in need (what income for a couple is equivalent to an income for a single person for meeting needs?) – this concept alone can twist into unfairness.  Imagine a parade of dwarves – not real ones, this income one here:

https://www.theguardian.com/society/datablog/2012/jun/22/household-incomes-compare

All along this parade we have people organised by their incomes – from lowest income to highest income.

A Gini coefficient gives us a summary measure of this parade, by looking at the absolute distance each of these people are from all the other individuals in the parade.

So say we walked up to this parade and took the person at the back (the poorest person) and swapped their income with the person at the front (the richest person).

What happens to the Gini coefficient after this change?  Nothing – everyone is still the same absolute distance from other people.

But what about VE?  The wealthiest person has paid proportionally more than the poorest person (sacrificing nearly all their income and giving it to the poorest person) and so there is a disproportional transfer which meets our definition of vertical equity!

So even though the Gini coefficient is unchanged, this policy change refers to a progressive transfer and so produces vertical equity.

But there is an issue.  If we have no reason for valuing one person above another (anonymity) then we can see that this transfer has just swapped the position of two individuals – specifically there has been no reduction in income inequality, instead the policy has just changed who is in what position.

If we were to reorder the parade of dwarves into the same ordering by after policy income, the person at the top who lost all their income would move to the bottom while the person at the bottom who gained all the riches of the top person would move to the top.  As a result, their relative position in the income parade changed!  This is termed reranking.

As a result, we can have a progressive transfer that takes from those with higher incomes and gives to those on lower incomes – but if that transfer changes the relative incomes of individuals (thereby leading to reranking) it leads to a smaller reduction in overall income inequality than this progressive transfer alone would suggest.

Reranking is often termed Horizontal Inequity (although as we get into in the future, it is only one type of HI) as given the assumption of anonymity a transfer that is so large it swaps the relative position of a higher income individual and lower income individual appears inequitable.  Given VE simply states that those on higher incomes should pay proportionally more it does not rule out circumstances where they pay so much more that they end up worse off than people who were below them on the income parade.  Reranking captures that difference.

I thought you were going to measure these things?

As stated, reranking involves allowing the income parade to be reordered after a tax-transfer policy is introduced.  So reranking compares the income parade before this reordering, with the new post tax-transfer incomes to the income parade after this reordering.

When measuring VE and reranking we take advantage of the fact that these orderings correspond to different income parades, and calculate summary statistics that represent these parades.

The initial income parade can be thought of in terms the share of cumulative income as we move from the poorest to the richest person – the Lorenz curve.  The Gini coefficient is then a summary measure of this Lorenz curve.

When a progressive transfer is introduced we can keep everyone in the same order, but the density of income will rise towards the bottom of this curve.  The summary measure of this is the concentration coefficient from this curve (Note:  The Gini is just a concentration coefficient too but ordered from lowest to highest income in whatever income we are discussing).

Once reordering occurs based on the new incomes we get a new Lorenz curve for post tax and transfer income.  The Gini coefficient for this can be thought of as our summary measure of that distribution.

Vertical equity is then shown with regards to the difference between the Lorenz curve for market income and the concentration curve for disposable income – these are simply cumulative income of each measure for the same ordering of the population (by market income).  The difference between these curves tells us if people who had higher market income were paying proportionally more!

Reranking is then the difference between the concentration curve for disposable income and the Lorenz curve for disposable income – or in other words the same disposable income numbers, but ordered in different ways.  If no individuals changed position these would be the same thing!

You’ll notice something.  VE takes us from the original Gini to another number, then Reranking takes us from that number to the new Gini.  As a result, the change in the Gini coefficient after we introduce policy (commonly called the redistributive effect) can be nicely split into a change due to VE (transfer from richest to poorest) and reranking.

How can we think about this?  Say we have some target redistribution and we want to to achieve for some reason.  A system that has less reranking can do that with a less progressive tax-transfer system than a system that has more reranking.

A super clear description of this can be found here.  And I’ve discussed it here.  For clarity I’ve also been giving visual examples in a presentation of my results -> Nolan VE-HI presentation.

Cool, so the transformation of market income to disposable income – given the same ordering – is VE.  I have an idea that ….

Wait.  Urg things get a bit ugly here.

This is an estimate of VE, but eagle eyed readers may noticed something is missing.  Why doesn’t the imposition of policy change MARKET income as well.

What are our “counterfactuals” here.  One scenario with policy and one without.  A world without tax and transfer policies will have a different market distribution of income as well … which implies that VE is wrong.

Now people who write this literature (eg people like me) make the claim that we are looking at policy changes and considering the CHANGE in VE (not the level).  As a result, we assume that the distribution of market income does not change due to this.  This implies that we have to be a little bit careful with the measure.  I like the way it is described here.

The fixed-income approach proposed by Kasten et al. (1994) provides a straightforward framework to isolate these effects. Widely used in the literature on income redistribution and tax policy, this method provides a baseline for the identification of policy effects by keeping the distribution of market incomes fixed and by applying the tax and benefit schemes of different periods to this distribution of reference.

It is important to recognise, however, that this approach only isolates what we could call the immediate policy effects as it does not account in any way for behavioural responses to these policy reforms.

Well, what is the bias then?

Great question.

So for this we need to figure out how the introduction of the tax-transfer system would change market income.  Or if we focus solely on changes, how the change in the system would change market income.  Here we need to answer questions such as:

• Who faces the incidence of tax due to these changes
• How do patterns of employment and capital expenditures change following these changes
• How will the characteristics of households change following these changes

This is more than a question of “will wages rise”.  It is a question of “how will the distribution of wages be influenced by the change in the tax-transfer system”.  And these will depend on the type of policy that was used to introduce a change in progressivity – not just the fact that the tax-transfer system has become more progressive!

For some hypothetical examples where we are keeping the average tax rate fixed but changing progressivity we can say:

1. If redistributing income does not change any behaviour and the full payment of tax-transfers occurs by households then nothing happens … this is the “fixed income”.
2. If redistributing income does not change any behaviour, the tax-transfer system is levied on individuals, the tax-transfer system is linear in income, and the actual tax payment is equally split between households and firms then a more PROGRESSIVE tax system will INCREASE pre-tax income inequality … and thereby exaggerate the amount of VE as the “true” inequality in pre-tax incomes without a progressive tax system would be lower.
3. If by redistributing income we reduced investment in the capital used by low income earners then the amount of VE caused by the tax system would be overstated.
4. However, if by redistributing income we increased the incentive for low income earners to enter the labour market the amount of VE caused by the tax system change would be understated.

Man, those examples hurt my head – and it is not very evident which way the bias goes in a very complex system (both the economy and tax system) such as the ones we observe in reality.  I have guesses I would hazard, but I’m not going to.

I haven’t seen this type of work undertaken for VE (Kasten et al (1994) discuss it with reference to EMTRs) – but that doesn’t mean it isn’t important

Ok, what about HE – I think that is very important to me

Nice question.  I have no doubt Horizontal Equity (HE) is important to you, real important.  Constantly we hear about discrimination by sex, race, and even age.  On top of this we may view treating those with the same initial income as violating horizontal equity.

But this post is already long, so I’ll leave this discussion for another time – I tell you what though, it will be a doozy … or at least long again!

Anyone who reads this who also read my writing pre-2014 will remember that I was a strong post-distributionalist when it comes to social insurance policy.  To the point where the term pre-distribution (or predistribution) did not appear on TVHE when I did a search.

Since then the economic environment has changed and I have spent more time considering these issues.  So have my views changed?  Let’s consider the issue.

Tl;dr No, but I think the terminology can be used more clearly. With regards to redistribution – if our concern is the distribution of income alone pre-distributionalist policies are indirect and inefficient.  But pre-distribution policy prescriptions have relevance when discussing issues of transition – which is essentially insurance from shocks, and the provision of job/income security (as apart from a security net).  Such insurance can be costly, but is still worth discussing in this frame. Furthermore, if we stretch the term pre-distribution far enough it becomes ridiculous – sure the whole study of economics concerns the distribution of income, but the name is used for a subfield for a reason.

Definitions

Contrary to Wikipedia pre-distributionalist policies are not new.  Until the reforms of the Fourth Labour government in New Zealand, New Zealand social policy was heavily pre-distributionalist.  Now this, from the bat, suggests to me that my definition of pre-distributionalism (which is based on reading of welfare and tax policy history in Australiasia and Scandanavia where this term can be used to differentiate from tax-transfer policies) may differ from modern discussions (which I have not read).  That is fine by me but I will try to be clear on issues below so it is obvious what I am talking about.

So what is pre-distributionalism as I discuss it here?  I have always interpreted it as stating that a pre-distributionist redistributes the means and structures for generating income prior to trade occurring, rather than redistributing the income generated from trade (post-distribution).  In both cases the purpose of this policy is then to redistribute income to deal with some perceived inequity in society.

A post-distributionalist policy would be something like an unemployment benefit, while a pre-distributionalist policy would refer to a government guaranteed job at a given wage rate for a worker in an industry that is fading away.  A post-distributionalist policy would be to provide a family benefit for those with children, while a pre-distributionalist policy would be to influence wage rates in industries where parents tend to work to increase their market incomes.  Both are redistributing income and providing a form of income security – but the incentives, costs, and benefits differ.

Now I’ve heard that pre-distributionalism can be steered away from the line that it is redistributional – instead stating that they are preventing inequalities from occurring at the source.  I dislike this, as it makes the success of pre-distributionalist policies untestable – if income inequality was to fall they would claim success (through redistribution) and if it didn’t they would claim that the underlying inequality they were dealing with was dealt with by definition.  If there is a “non-income” type of inequality we are targeting, then any dichotomy between pre and post-distributionalist policies is false, as the only real point of post-distributionalist policies is to change the distribution of income.  Note:  Many “inequalities” are in fact unobservable or are justifiable.

But this cuts to the heart of the issue – if we are going to evaluate policies we actually need to define what the aim of the policy is.  In this way I would argue that we can split policy targets into three when it comes to setting these policy schemes:  The first two are static – the level and dispersion of income/final goods and services.  The third is dynamic, in the face of shocks who bears the risk.

You may argue there is a fourth string – that the structure of returns are efficient and equitable!  If that is where pre-distributionalists are referring to then all they are saying then the entire term is pointless for two reasons – as it refers to all policies that are not tax and benefit policies, and refers to their final evaluation rather than a description of their distributional properties!  Note:  Post-distributionalists don’t get off scott-free here for jumping too quickly to welfare evaluation – this is a whole other kettle of fish though.

So yes these policies influence the distribution of income, but the distribution is not the “purpose” of them – instead they are targeting some other equity or efficiency principle.  This is the same category error people make with monetary policy and financial stability.

What do I mean – yes we should talk about the distributional impact of all policies, but the “target” of all policies shouldn’t be focused on its impact on the distribution of income … or even worse some undefined inequality that we will just say is solved as a result of our pet policy .

Note:  If someone was to say “I think competition policy is more relevant to welfare than something that merely targets reducing the observed inequality in incomes” I would say “yup”.  But by saying you are a type of “distributionalist” you are stating that the primary concern of your discipline is the distribution of income.  Also remember that someone who focuses on post-distributionalist policies doesn’t disavow other policies – they just aren’t trying to move every potential policy recommendation into their field of research …

The distribution of income 

What is the distribution of income?  We can think about it in the following way – we have some characteristics (I’m male, 32, eat poorly, have experience working as an economist, and like to argue far too much) and the market offers us a set of potential jobs given these characteristics.  They offer different combinations of income, work satisfaction, and leisure – we then fall into one in some way.  On top of that if we are endowed with resources we can save them in some way where there is a set of risk-reward opportunities for our saving – these generate income.

Nice.

So the distribution of income depends on endowments (savings, characteristics) and the return on offer for these.

Nothing in this about the fairness generating the process – and the process itself is very much a function of policy.  However, after we have introduced a series of policies that give a “structure of returns that are efficient and equitable” is the outcome just?  Maybe, but maybe not – due to insufficient information about the income generating process or due to luck.

As a result, we in turn justify redistribution.

Redistribution of income

If all we care about is income alone, then post-distributionalist policies get us where we want to go with certainty – in that way, they give us greater income security and horizontal equity over the population as a whole.

For example a job guarantee may offer an individual greater income security than the existence of a safety net – but if those guarantees are in areas that are unprofitable this is really a benefit payment from society.  By making broader society bear the risk that the job has value you creating uncertainty about the required tax.  Furthermore as this person has a higher guaranteed income than people with otherwise identical characteristics by virtue of having this job, there is horizontal inequity.

Furthermore, we can do a better job of targeting with post-distribution – as at this point we have “observed” things such as luck, or the product of unobserved characteristics (observed income).  As a result, redistribution that will have been missed by pre-distribution gets picked up by post-distribution – but this does not happen the other way.

In terms of efficiency it is often assumed that post-distributional policies are superior to pre-distributional policies.  After all, job guarantees keep people working in roles where they are producing little, while a social safety net clearly demarcates the difference between work and benefit income – incentivising people to look for roles where their work is valued.

Job schemes in New Zealand helped to hold down the reported unemployment rate in New Zealand through the 1970s and early 1980s, but they were incredibly wasteful – in most cases providing people differential benefit levels for not doing much.

But this does ignore something – people were still going to a job, a job they did not believe would disappear.  And that leads us into another separate issue.

Economic security

Now, post-distributional policies are sufficient for economic security when shocks are only very small – they provide a safety net, and people are relatively fluidly able to move being job types.  Such policies are set given considerations of relative status and equity already and so there is no need to consider more active intervention.

But technological change, globalisation, and the GFC (which arguably helped to speed up some of these changes) imply a situation where the return to the skills people have has changed significantly – with some people rewarded for training in areas that are complementary to technological change while others have seen their income and job prospects disappear.

We should not want to make the past reappear.  Technological change and globalisation generate wealth.  But, arguably, we may believe that such a change is only fair if the losers are compensated by the winners – if the compensation we discuss for Kaldor-Hicks efficiency actually takes place.

Now this is an issue I find incredibly difficult.  This is an area I do not envy policy makers.  We cannot just tax the winners from globalisation and give income to those who, in the absense of change, would have been better off as:

1. We don’t have sufficient information
2. If we view it in too static a sense, it may excessive mute incentives for people to develop skills that suit the new reality
3. Income isn’t the only issue that matters – pride in having a task you perform well and the status that gives you in your community are also important, and are lost.

As a result, arguably a potential pareto improvement from a policy involves both pre and post-distributionalist policies.  Furthermore, the cost-benefit analysis of such policy changes needs to count such transitional shocks.

Now, this is already how economists generally consider such issues.  Look at this article by Benje Patterson from 2013.

A generation of workers in Southland’s labour market have become institutionalised in the Tiwai environment.  Subsidised power led to the creation of well-paid positions and accrual of skills that would not have otherwise been demanded by the wider labour market.  This artificial disjoint would leave some former Tiwai employees with a tricky transition into comparably paying employment should the smelter close.

Parallels can be drawn between the current situation for Tiwai’s employees and car assembly workers left jobless in the late 1990s. Both industries flourished because of some form of government intervention.  Tiwai survives because of preferential power pricing, while New Zealand’s car assembly industry only ever existed due to sizeable import tariffs on cars.

Not surprisingly, when the government decided to withdraw these protective motor vehicle tariffs in 1998, domestic assembly plants could not compete with the price of imported vehicles and were forced to shut down.  These closures left thousands of car assembly workers jobless.  As with Tiwai, many of these assembly workers had dedicated a large proportion of their working life to an industry whose labour demands were quite different to those of New Zealand’s broader labour market.  However, despite this disjoint, additional support from the government to help with their transition into other employment was not forthcoming.  The government gave a mere $400,000 of funding for communities affected by car assembly job losses on top of normal social support and employment assistance.

I find this lack of additional support somewhat callous.  Car assembly workers had acquired a specific skillset on the understanding that society wanted to support the industry, as a result, the government’s decision to remove car industry tariffs essentially boiled down to changing an implicit social contract.  The government should have recognised its role in the problem and gone out of its way to assist these workers’ reintegration into the labour market.  It was a change in government policies that undermined the value of the human capital these workers had developed – which suggests that as a matter of fairness, these workers should be compensated for that loss.

Pre-distributionalist policies (at least the ones that make sense) occur within the scope of compensation for an economic shock.  These are positive sum games where some of the people involved have lost out – if we want to make sure people in society are still willing to play these games, we have to ensure that they aren’t (and don’t feel) taken advantage of.

If this is the crux of the discussion around pre-distributionalism then it is worth talking about.

If pre-distributionalism is really about power structures and competition policies using different terminology then that is nice and all, but I don’t see the need when a clearly communicated prior literature on these issues already exists – and requires absolutely no conflict with post-distributionalist policy.

The review doesn’t break any new ground but it is eloquent and engaging. Her central themes are:

1. The Industrial Revolution and Great Enrichment have increased incomes by 2,900% over the past two centuries. They have elevated the poor to a state of wealth, relative to their lot even fifty years ago. It is that increase in the absolute lot of the poor that we should be ethically concerned about, not the relative inequality that Piketty focuses on. Considering their capabilities and dignity, not simply incomes, is even more encouraging because of advances in, for example, access to education.
2. Piketty focuses on the accumulation of physical capital but the engine of growth for the past 200 years has been human capital. The exclusion of human capital from his calculations is particularly problematic because it is owned by the workers, not the capitalists. That growth has enriched the poor by magnitudes more than redistribution could achieve.
3. Wages and capital returns are important price signals that generate a response from supply. Stifling those signals damages the efficiency of the economy and retards the very growth that will help the poor.

As I contributed to the related book of book reviews, and as this particular event is in Wellington (where I live), I’m on the panel.  Here are the details which I stole from an email:

The event is at the Royal Society (11 Turnbull Street, Thordon) and begins at 5.30pm.

 

Bernard Hickey is chairing the panel, with the other panellists being Geoff Bertram, Brian Easton, Prue Hyman, Max Rashbrooke and Cathy Wylie. 

 

The aim of the event is simply to have some broad and engaging discussion on the relevance of Piketty for New Zealand, with reference to the book being launched on the night. 

And if it swings your boat, you can even join the Facebook event.

If you want to prepare beforehand, here is my long-form review (filled with typos – like honestly filled, it is a first draft that never went any further), here are some common misconceptions, and here is a list of other reviews.

The reason for this interest in Gini coefficient stems from the fact they are used to measure “inequality” in an income distribution – with books such as the Spirit Level made hay discussing the relationship between Gini coefficients and other social outcomes.

Now I’ve spent a bunch of time talking about the claims (eg for the Spirit Level directly I wrote this and this), but I’ve never written anything directly about the Gini coefficient.  There is a good reason for this, while I understand it is a measure of dispersion in a distribution I still had to (and still need to) learn things about the measure and other measures.

However, let me discuss what the Gini coefficient is – or at least one of a multitude of different ways we can view a Gini coefficient.

Forget for a second that the variable of interest is income – and let us just think that there is some data we are trying to discuss.  Many of you will be used to the idea of the mean of our data and the variance of our data – and the relationship this has to the “population” values.

We can think of these measures more generally in terms of moment generating functions – where these moments in some sense describe the distribution in terms of the mean, variance, skew, and kurtosis.  This is very useful stuff, and can give us a solid understanding of what sort of data we have in front of us.

However, when we want summary indicators we know we have a bit of an issue with the data set we are looking at – it is right skewed.  In other words, there is a very long right tail for our income distribution, and (if the data is unimodal – which it isn’t ) we will have a situation where mode<median<mean.  In this case, the central tendency we are interested in discussing for the distribution may not be appropriately described by the mean – hence why it is so common to discuss median income when talking about income distributions.

Cool.  However, given this it is still very common for us to turn around and think in terms of “variance” when discussing the statistical dispersion of a series – even when we know we have a situation where the data has a right tail and we discuss the median as our summary statistic for centrality.

Although the variance is commonly defined as the squared difference between an expected random variable from the distribution and its mean, the variance can be rewritten to be independent of the mean – as a result, it is common to keep using the variance to describe statistical dispersion.  However, there are a couple of reasons we may not want to use the variance when discussing income inequality as a type of statistical dispersion.

1. The most common complaint is that we are interested in “relative” inequality as it is “objective” (this term is in inverted commas on purpose – read it as saying the value judgments are clear, making analysis easier).  As a result, we want our measure to be normalised (dimensionless or scale invariant).  In this case, it would be common to use the coefficient of variation.
2. The variance uses a different “distance function” than other measures of dispersion – in some cases, the implied distance function used by other measures of dispersion is more appropriate.

An alternative in this case is to look at the expected absolute difference between two realisations of a random variable from the given distribution.  This is the Gini mean difference.

Both the variance and the GMD can be written in terms of weighted average of the difference between adjacent observations.  However, it turns out the distance function that is used by the variance puts greater weight on extreme observations than the Gini mean difference does (where the Gini coefficient is a normalised version of the GMD) – similar to the concern we had about using the mean instead of the median.

This alone doesn’t tell us we should use the GMD instead of the variance – but in the same way we may sometimes prefer the median to the mean to give us a summary measure of something about the distribution, there are times where the GMD (and the Gini coefficient) gives us a more useful summary measure of dispersion than the variance.

For those interested in more details about why we’d use the GMD instead of the variance in some economic applications, and for those who actually want to look through the working, I suggest having a peek at the Chapter I linked at the start of this post.

Yawn

The key point I’m trying to get across here is that Gini measures are not mystical values that tell us what is fair or just – they are a certain measure of statistical dispersion, one that bears a relationship to measures such as the variance.  We can only interpret what these mean if we can understand the mechanism behind them – namely, why is income distributed in this way.  This is the most important step, and yet often seems to be the one people are most happy to just ad hocly throw together

In other words, the income distribution is an outcome from some process which involves individual choice and policy.  We need to understand “how” this happened in order to describe what the counterfactual position would be if we changed policy.  This gives us our description of policy.  It is only then by applying value judgments that we can say one outcome is better to another.  Merely running around after a measure of statistical dispersion misses the point that there may well be trade-offs between some outcomes and the inequality measure, and that some inequality associated with this measure may be “good”.

However, in this instance the data he is using and his interpretation is sadly a bit off.  I thought I’d discuss why this is here.  In his post he states:

Incomes increased by 4% from 2011 to 2013. But economic growth during that period was a lot higher than 4%. The sum of GDP growth/quarter from the start of 2011 to the end of 2013 is 8.9%. Pikkety argues that what you’d expect to see in a typical capitalist economy is income growth that is a lot lower than economic growth, and the bulk of the wealth created by new growth going to the owners of capital.

That’s not quite what we’re seeing here. About half of wealth created by growth is going to income earners but that’s going to the top half of earners. The rest is, presumably, going to the capital owning class, mostly the top 1%.

If that is the case – and remember, I’m just a left-wing blogger who happens to be 11% of the way through a popular economics book – then the gap between the haves and have-nots is, actually widening. It’s just not doing so purely through income distribution.

Let us take period for period.  The 2014 HIR is using the 2013 HES (Household Economic Survey), which involves individual survey’s between July 2012 and June 2013.  Expenditure GDP in the year to June 2013 rose 5.5% from June 2011, production GDP rose 5.1%, and we don’t know what income GDP did quite yet.  In theory the three should be the same – but measurement error

Furthermore, the increase in income figure is a per capita figure – the lift in GDP is an aggregate figure.  However, the average population in the June 2013 year was 1.4% larger than in the June 2011 year.  Putting all this together, a 4% lift in average income sounds about right – if anything it may seem a little bit strong at first.  However, if we then take into account that real GDP isn’t really income – as it doesn’t take into account transfer flows overseas (interest payments, dividends) and changes in export and import prices – then we may instead look at a figure like RNGDI to give us an idea.  If we thought RNDGI per capita was appropriate, we would think the HES is maybe a bit excited – as it rose by 2.9% during this period (as compared to 3.6% for prod GDP and 4.0% for exp GDP) [all data via Statistics NZ’s awesome Infoshare].  Let us even throw up a graph of 2 year growth rates in per capita measures for kicks!

[Sidenote:  Don’t forget the HES figure is also a median – so it does depend on how the distribution of income has changed.  Also, the equivalisation of households and corresponding change in the distribution of households can be pretty important.  As the report says the increase was quite proportional so we’ll just ignore these things  ]

Now there are deeper points.  Say that the data was really different, does that mean that capitalists have been doing something.  Well no, this was my comment on his post:

The capital owners are in the HES, as domestic capital owners are also “households” in econ lingo – the key thing is that different measures of income give very different results. Practically the national accounts figures, tax data, and household surveys don’t match up a lot of the time – and given the type of data available distributional work was more appropriate with household surveys and analysis of aggregates was more usefully done with national accounts data.

The cool thing with Piketty is he has put a lot of work trying to create data that gives a representation of the functional/macro distribution of income (based on classes, eg capitalists, labour). And while this is great, it doesn’t bear a relation to household survey data – as people in those surveys are “part labour” and “part capitalist” (as well as reporting differences in time period, accuracy, etc – big thing is that a lot of the “long tail”, esp with capital income, is believed to be underreported in HES). So I don’t think we can make the claims you’ve put down here – as the HES data doesn’t measure the same things as the Piketty story.

Thinking about how Piketty’s analysis fits into NZ is important though, I heard that there is work being done on that around the place at the moment – will be interesting to see what that tells us. A key thing I’d keep in mind is that, if we look in income share in the national accounts, profit share hasn’t been rising – furthermore, if we look at the top 1% data there hasn’t been much movement there. New Zealand doesn’t have the same inequality issues or productivity increases that we’ve seen from the accumulation of capital overseas – I wouldn’t be surprised if there was a link between the two! Something I was hinting at with this: http://www.tvhe.co.nz/2014/02/05/ict-factor-shares-employment-and-inequality/

Don’t believe me, let us go to the HES site:

The survey also asks for detail on where households get their money from – for example, wages and salaries, self-employment, investments, or benefits.

Data comparability is a pain.  Even think about the way we “deflate” these different things, GDP uses the GDP deflator while the HES is using CPI – they represent fundamentally different views on the basket of goods we are adjusting with, and with respect to, when we figure out income!  What about depreciation, should we really be including the replacement of capital stock as income – this is a big question, and the right response depends on what sort of underlying questions we are trying to answer!

And there is also the post Brian Perry makes that the data is very volatile given the sheer upheaval of an economic crisis and Canterbury earthquake.  In this context, the 4% figure is itself reasonably uncertain let alone the difference between groups and the level of dispersion in incomes!!!  Trying to fit too much of a narrative around the last few years doesn’t make much sense – income data needs to be viewed with longer term trends.  This is what Piketty tries to do in his text – not to define transient movements in such broad brush terms

Given this we can get back to the broad Piketty story.  The Piketty story doesn’t fit New Zealand data that well right now – it is a multifaceted story based on a certain view of the relationship between labour and capital which, combined with slowing population growth, leads to growing dispersion in income from wage earners to capital owners.  We don’t have growing capital accumulation, we complain constantly about a lack of “capital deepening”, and the World Top Income database suggests that the “Top 1%” figure hasn’t seen the same dramatic rise as overseas.

Instead, New Zealand has a very different income inequality story – one that Brian Easton has been chatting about.  Essentially there were a bunch of reforms back in the 1980s – although much of the data only started to be measured in a consistent way between 1986/88 there is an agreement that income inequality rose in the late 1980s and early 1990s.  It then settled at this new higher level.  What drove this, whether it is “fair” or “unjust”, and how we should consider policy given is the issue – and this issue hasn’t changed since it was being debated at the time.

Income inequality isn’t a new and worsening issue in New Zealand – it is the same old issue around the reforms that has always existed.  There is nothing wrong with having that debate again – we do not have to pretend we are another one of Piketty’s countries to have the discussion!  So I am glad he is discussing the issue, I just think we can get pretty far in discussing whether things are fair by considering the pretty objective discussion put out by MSD (it is seriously just reporting the data) with regards to the ethical principles we may hold – rather than mincing up different data sets in an inappropriate fashion.

Note:  I have no interest in taking sides around redistribution.  My sides are personal, my blogging is just about considering the questions.  Both sides can make valid and compelling arguments about more or less redistribution.

Sidenote:  I’m not sure what this meant:

Pikkety argues that what you’d expect to see in a typical capitalist economy is income growth that is a lot lower than economic growth

At 11% in Danyl will have hit the r>g inequality – this is the situation where the return on capital is greater than economic growth/income growth.  Piketty is using income and economic growth as interchangeably – as in the long-run we’d expect measurement problems to wash out and this to be the case.  I suspect this is where he accidentally created a “capitalist” class that doesn’t exist in his addition – the capitalists are in the income and GDP surveys just like everyone else!