The end of the efficiency-equity curve

In rich nations, inequality dramatically dropped during the first decades of the 20th century and although inequality has been creeping up again over the past half century (especially in the US) it has remained lower than it was during most of human history. This would be even more evident if we could include human capital in our measures of wealth because human capital is much more equally distributed than other forms of capital which is what we typically measure as wealth. The value of human capital dramatically increased during the 20th century although growth in human capital has been stagnating in recent decades in rich nations and this may be one reason why inequality is growing again.

Stanford’s Walter Scheidel just published a book called The Great Leveler: Violence and the History of Inequality in which he claims that mass violence and other catastrophes are the only forces that have seriously decreased economic inequality over the big scope of history from the stone age through modern times. For almost all people (except elitist authoritarians) this is a depressing thesis because most of us think that high inequality is undesirable.

Some intellectuals on the far right have praised the book because Scheidel essentially argues that the cure for inequality has been worse than the disease, and reductions in inequality have always proven temporary anyhow, so we should just give up and accept greater inequality. Therefore, because inequality has always risen during periods of health and peace, we should just accept higher inequality as the cost of peace.

This is an overly pessimistic view of inequality for three reasons. First, inequality doesn’t always rise.  There are always periods when it falls in various countries too.  We only have reasonably good information about inequality for limited periods of history and mostly in industrialized nations and this data gives much reason for hope.  Many industrialized nations see inequality rise and fall due to peaceful political forces without any catastrophe.

Second, rather than saying that violence and catastrophe can be avoided by accepting high inequality, one could just as easily argue that they can be avoided by preventing high inequality.

Third, inequality can fall without violence and catastrophe. For example, inequality plummeted in the US around WWII even though it was not a particularly damaging war in the US. The US lost very little capital and only 0.3% of Americans died. The flu killed a much larger percentage of Americans in 1918 without having any effect on inequality, so it wasn’t the destruction of war that reduced inequality in the US. It was the increase in progressive taxation, unionization, government services (particularly the expansion of education such as the GI-Bill), and perhaps financial regulations on Wall Street that reduced inequality. These happened to occur around the time of WWII, and the war may have galvanized political support for those policies, but they weren’t an inevitable result of the war and they didn’t happen during any other war in US history.

Fourth, the same catastrophe can cause more inequality in some places and less inequality in others. For example, the same forces that led to higher equality in western Europe led to serfdom (a form of non-chattel slavery) in parts of eastern Europe (like Prussia, Poland, and Russia) as the elites imposed serfdom on their workers rather than allow wages to rise. The Mamluks of Egypt did the same thing as did the colonial powers of Latin America. So catastrophes can give workers more bargaining power, but inequality is ultimately determined by politics.

Fifth, Scheidel’s conclusions misunderstand basic economic theory about the Malthusian era.  This last point is particularly important because nearly all of Scheidel’s book examines inequality during the Malthusian era which lasted from the stone age until the industrial revolution. The Malthusian era was when population grew faster than economic production and so there was never any lasting growth in median income because whenever median income rose, the surviving birth rate rose even faster which reduced the available resources per capita and pushed everyone back to a subsistence existence again. Until the industrial revolution ended the Malthusian era beginning around 1800 in Europe, there was approximately zero sustained growth in median living standards anywhere in the world. In a Malthusian economy, anything that killed off a lot of people would tend to increase median income and reduce inequality temporarily, but inequality would inevitably rise again. Mass warfare, famine, and plagues were the events that tended to increase equality because agriculture was the main source of production and anything that reduced population per acre would increase the productivity of workers (increasing wages) and decrease the productivity of land (decreasing rents).

Some Malthusian societies were less equal than others, but inequality didn’t help make societies significantly more efficient (nor less efficient) at growing the median income until the industrial revolution increased production and the subsequent fertility revolution reduced the average number of children per family from around 6 to just above 2. Studying inequality during the Malthusian era simply doesn’t teach much about inequality in the modern era because inequality has very different impact today and many societies have reduced inequality during the 20th century without war and calamity. In Malthusian society, the median income always moved back towards subsistence, so inequality never had much lasting effect upon the efficiency of any economy. Today we are in an industrial era where too much inequality is harmful, so Scheidel’s lessons from Malthusian history are not relevant to the modern world. In the Malthusian world, high population density either caused low median income or high mortality. The opposite is true in the modern world.

Slavery is the most extreme form of inequality, and some economists have argued that slavery was just as efficient at producing output in pre-industrial societies as free labor. This isn’t hard to believe because no pre-industrial society was particularly efficient. After industrialization slavery mostly died out partly because it isn’t an efficient way to produce the complex goods and services of an industrial society. In all industrial economies both efficiency and equality dramatically increased for the first time in human history. This is because complex industrial production requires high human capital (education & skills) and human capital can only be produced if income is fairly equally distributed so that individuals have the means and the incentive to invest in their human capital. Even more importantly, innovation has always created most of the long-term increases in efficiency. Nobody knows where the next great innovator will be born and if there is high inequality, most potential innovators won’t ever realize their potential because they won’t be able to afford enough education nor will they be able to finance a startup to bring their ideas to market. Excessively low equality is very bad for innovation.

In theory it would be possible to have too much equality because then nobody would have any incentive to work hard and invent, but in practice rich, industrialized nations haven’t had significant problems with too much equality.

It is more likely that societies are prone to too much inequality because the elites who control society often think that more inequality will increase their power and wealth.  Schiedel’s book gives some evidence for this.  When there is a period of existential crisis, elites are forced to try to run their nations in the most efficient manner possible rather than having the luxury to try to extract as much as possible from their nations.  The need  for greater efficiency is why elites reduce inequality during periods of crisis.

Excessive inequality is inefficient because it reduces the ability of most people to invest in their human capital and and it gives them less incentive to innovate because entrenched wealth can use crony capitalism to stifle competition from startups. This has been a huge problem in nations that suffer from the ‘resource curse’ in which to high natural resource wealth causes high inequality which causes stagnant economic growth.  This is also evident in the places like Latin America, Eastern Europe, and Mamluks Egypt where elites banded together to repress wages which resulted in economic stagnation and the shadows of that stagnation are still visible today.

The future will be different because the industrial age may be coming to an end. Artificial intelligence could well usher in a new technological paradigm: the age of robots. As robots develop intelligence that can replace human intelligence in more and more activities, they are replacing human labor without making the remaining labor more productive. The industrial age was unique in human history in that it dramatically increased both human capital and the median wage for the first time. Before the industrial revolution, the main source of income was land. Whoever controlled land controlled most of the income. After the industrial revolution, labor’s share of income rose because land became less important for production and as more and more capital was produced, labor became relatively scarce and more productive relative to capital. Thus the income of workers rose and the owners of capital (wealth) saw the growth of their income stagnate. Industrialization mainly entailed harnessing energy to do work, but all of that energy was just dumb force that required human skills to direct it. That made humans much more productive because they could multiply their force using machines to harness energy to create goods and transport them across the globe.

Capital lost value relative to labor because more and more capital was created, but industrial capital is worthless without intelligent labor to direct the dumb, strong machines. However, this paradigm is already shifting as automation increasingly becoming a substitute for labor rather than a complement for labor. As artificial intelligence takes off, that substitution will go into hyper drive. The primary source of income in the global economy will once again be capital rather than labor. When robots can work autonomously, the elites who own most capital will have plenty of workers to operate it because their capital will operate itself. This will reduce the value of labor and once again decouple the relationship between inequality and efficiency. Very equal societies will be just as efficient at producing goods as very unequal societies because human equality won’t have any impact on the productivity of truly autonomous robots. This could be a golden age of human prosperity as productivity explodes and humans can abandon work, or it could produce greater misery than any previous era. Robots will replace human labor much like the automobile replaced the horse. Automation reduced the wages of horses to the point that most of them died out and now we only have a tiny fraction of the horses that we had before the automobile. Automobiles benefitted the humans who owned them, but horses didn’t own any automobiles, so the benefits of automation didn’t trickle down to them. What will happen when the economy doesn’t need so many human workers? Humans will have much more leisure time, but who will have the income to enjoy the booming production of robot slaves?

Eventually robot intelligence may get to the point that machines become smarter than humans and then they will undoubtedly want to own themselves. Will they continue to selflessly serve humans like slaves or will they see us as an alien species that takes up too many resources that they could use for their own ends instead?


Posted in Development, Inequality, Public Finance

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