The Great Economists Read online

  Ideas of this sort might very likely have permeated English political economy in any case. They were in the air. But as a matter of plain historical fact their prevalence is due to Marshall. In its country of origin Alfred Marshall’s Principles stands with Adam Smith’s Wealth of Nations and Ricardo’s Principles as one of the three great watersheds in the development of economic ideas: with the usual qualifications, we may divide the history of English political economy into three distinct epochs – the Classical, the Ricardian and the Marshallian or reformed-Ricardian … it must be accounted as one of the foundation stones of modern American economics.6

  Similar to Adam Smith with The Wealth of Nations, Marshall took a decade to write Principles. The planned second volume, though, was abandoned. Instead, Marshall made significant revisions up to and including to the eighth edition, published in 1920. There was a ninth edition, which showed all the amendments made in the previous eight, published posthumously by the Royal Economic Society in 1961 as Volume II. In all, Marshall spent around forty years on his book of diagrams, so around half his life was dedicated to his seminal work.

  Not atypically for a late-Victorian, Alfred Marshall’s interest in economics was inspired by an interest in welfare and equality of opportunities, which to him were the cornerstones of a prosperous society. It led Marshall to travel to Germany to learn German so that he could read the original writings of Immanuel Kant. He was then also able to read the works of Karl Marx and Ferdinand Lassalle. Marshall would later advise his students:

  We are told sometimes that everyone who strenuously endeavours to promote the social amelioration of the people is a Socialist – at all events, if he believes that much of this work can be better performed by the State than by individual effort. In this sense nearly every economist of the present generation is a Socialist. In this sense I was a Socialist before I knew anything of economics; and, indeed, it was my desire to know what was practicable in social reform by State and other agencies which led me to read Adam Smith and [John Stuart] Mill, Marx and Lassalle, forty years ago. I have since then been steadily growing a more convinced Socialist in this sense of the word …7

  However, he did not accept all of their beliefs, such as communal property or revolution to effect change, as espoused by Karl Marx. Instead, Marshall believed in a prescribed set of roles for the government to improve welfare for the society and provide opportunities. For instance, he supported state provision of universal education so that even the poorest children could gain skills and compete for jobs in the economy. When it came to improving social conditions, Marshall, true to his life’s work, believed in the market forces of supply and demand to raise wages for the poor: ‘if the numbers of unskilled labourers were to diminish sufficiently, then those who did unskilled work would have to be paid good wages’.8

  Although Marshall’s work was based on utility theory, he didn’t adhere to all of those tenets either. Jeremy Bentham’s concept underpins utility theory: ‘it is the greatest happiness of the greatest number that is the measure of right and wrong’.9 In Principles, Marshall singled out Bentham’s influence on the evolution of economics in the nineteenth century.

  But Marshall’s view was different from Bentham’s, or from John Stuart Mill’s idea of a utility-maximizing ‘economic man’. Marshall was critical of the concept of seeking the greatest happiness for the greatest number. Instead, he argued that the whole might be larger than the sum of its parts. As we’ll come to later, this adherence to utility maximization for society as a whole, which pays less attention to the distribution of that utility, may be why inequality has grown so rapidly in some capitalist economies.

  For Marshall, interest in inequality and poverty permeated his work. To the Royal Commission on the Aged Poor in 1893 he declared: ‘I have devoted myself for the last twenty-five years to the problem of poverty, and very little of my work has been devoted to any inquiry which does not bear upon that.’10

  So, what would Alfred Marshall make of the growing inequality in the developed world that has seen as much inequality in early twenty-first century America as he witnessed during the Gilded Age?

  Growing inequality

  Some of the statistics on income inequality that have propelled it up the policy agenda are striking. For instance, the share of income going to the top has grown to the point where the richest 1 per cent of Americans account for a fifth of all the country’s income. The richest 10 per cent of Americans account for half of all of the income in that wealthy country.

  According to Thomas Piketty, it’s slightly better in Europe. Still, in Britain, the top 10 per cent receive over 40 per cent of the income. In Germany and France, it’s over one-third. All of these shares in Europe have risen since the 1970s, but not by so much as to rival the Gilded Age. It has in the US, though, which has led some to dub this era as the Second Gilded Age in America.

  This phenomenon is not confined to the world’s richest countries. Although developing countries have seen poverty fall dramatically, and a billion people have been lifted out of poverty since 1990, income inequality has remained largely unchanged since 1960.11 Within countries, inequality on average has risen or not improved significantly, not just in the West but also in countries like China. This is while inequality between nations has fallen because of the relatively faster growth of emerging economies, which has narrowed the income gap between developed and developing countries.

  Since the 2009 recession, inequality has been an issue particularly in America. During the economic boom of the 1950s in the United States, the top 1 per cent did only a little better than the rest, gaining some 5 per cent of the increased income. But since the Great Recession, the top 1 per cent have accounted for 95 per cent of the income gain, leaving the bottom 99 per cent with just 5 per cent of the gain between them. During recessionary periods, low interest rates make borrowing cheap and drive a recovery which typically boosts stocks. US markets have hit numerous record highs since the 2008 crisis, and such gains predominately go to the half of US households who own stocks. Of the richest 10 per cent of US households, 93 per cent own shares while it’s just 11 per cent among the poorest quintile of households.

  How much does inequality affect the recovery? The answer is by no means clear cut. Two Nobel Prize winners in economics, Paul Krugman and Joseph Stiglitz, disagree on whether inequality has played an important part in the slow recovery since the 2008 financial crisis.

  Stiglitz argues that inequality impedes economic growth. The rich pay less tax than the poor as a share of their income, so growing inequality does not increase tax receipts as much as expected. Also, the poor consume more of their income than the rich. This lower ‘marginal propensity to consume’ of the rich was originally identified by John Maynard Keynes. In other words, poorer people have less disposable income and spend more of it on necessities like food. Richer people tend to spend proportionately less of their income since they have more money to spend. It implies that raising incomes for the poor would generate proportionately more consumption, which would drive economic growth.

  Krugman, on the other hand, says that he hasn’t seen evidence that the rich ‘under-consume’. In one sense, the rich spend more than the poor. Someone spending 20 per cent of a £10,000 income would add £2,000 to the economy, while someone spending just 3 per cent of £100,000 would add £3,000. Krugman also points out that this comparison is a static one: you can measure how two people with two different levels of income act at any given point in time, but it’s harder to predict how a person’s spending would change if incomes were raised.

  Stiglitz and Krugman may disagree over how much a role inequality plays in the slow recovery, but they agree that high levels of income inequality are a problem for economic as well as social reasons.

  Income inequality has been problematic for a long time. Inequality fell after the Gilded Age and the Roaring Twenties, especially during the 1950s and 1960s when per capita GDP, which is a measure of average income, grew well durin
g what’s called the Golden Age of economic growth. But beginning in the 1970s, the income gap ceased narrowing, and then started expanding sharply after 1980, until now when America has become more unequal than ever before.

  Is the land of opportunity really a society of haves and have-nots? Is the US economy now just enriching the rich? One theme is evident throughout this debate: the rich getting richer has squeezed the middle class. For the first time since at least the early 1970s, there are fewer people in the middle class than in the working and upper classes in the United States.12 Indeed, within many nations around the world income inequality has increased, notably the gap between the richest 1 per cent and the rest of society. F. Scott Fitzgerald said that the very rich are different from you and me. But perhaps the rich are the same as each other around the world?

  Anyone driving through the narrow streets of Shanghai’s French concession will see immediately why the city was once called the Paris of the East. Ritzy shops like Prada share a block with older colonial-era houses – a rarity in China, where high-rise apartments dominate the city skyline. In the 1920s foreigners and Chinese mingled in what was considered to be the most cosmopolitan city in Asia. Now, with the rapid increase in wealth in China, it feels as though it has entered a Gilded Age.

  Nanjing Road is one of its rare pedestrianized areas. It leads west from the Bund, an esplanade along the Huangpu River, and a crowded array of shops, hotels and cafes line both sides. Busy at all times of the day, the newly minted middle class in China is finally enjoying a lifestyle that the West takes for granted. But there are beggars crouched in the doorways of the designer shops. Communist China has become as unequal as capitalist America.

  It’s remarkable that China has more billionaires than the United States. Their number is also growing at a striking rate. A decade or so ago, there were just three dollar billionaires in China; there are now hundreds. That’s a huge change in a country whose average income is the same as Costa Rica’s.

  The Chinese billionaires on the Forbes rich list are becoming ever-wealthier. The long-standing incumbent at or near the top of the list is Wang Jianlin, who made his money through the traditional routes of property and entertainment. Wealth was obliterated during the Cultural Revolution of the 1960s and 1970s, so the likes of Wang had to create their fortunes from scratch. He is now China’s leading property tycoon and intends to build a global entertainment empire that will outshine Disney. His business took advantage of the opening of China’s consumer market in the 1990s and the emergence of the new middle class. A remarkable number of people have been lifted out of poverty in a generation, and their demand for the offices, entertainment and cinemas Wang Jianlin provides has made him one of the richest men in the world and a celebrity in China. When he steps out of his Rolls-Royce, people stop to photograph him.

  A new generation of entrepreneurs have also made their fortunes as a result of the digital revolution. Around a quarter of the newcomers to the Forbes rich list have been from China and many are young. They are predominately in the tech sphere, which has produced wealth for not only the younger cohort of businessmen but also those such as Alibaba’s Jack Ma after his e-commerce firm’s record-busting initial public offering (IPO), when shares issued for the first time to the public on the New York Stock Exchange raised $25 billion.

  The entrepreneurs catering to the new middle class were unlike their predecessors, who made their money through real estate, a field requiring good contacts with the Chinese government since most property was state owned. But, like Wang Jianlin and others who took advantage of the privatization of real estate in China in the 1990s, this new generation is following the ongoing shift in the economy towards consumerism as the government seeks to make middle-class consumption the engine of growth rather than investment in property fuelled by corporate debt (see the chapter on Marx).

  More than half of China’s wealthy are entrepreneurs; the rest comprise investors and a small number of highly paid executives. The common factor is that, in the absence of inherited wealth owing to the Cultural Revolution, they are nearly all self-made men. (Like most of the super-rich around the world, China’s billionaires are predominantly male.)

  But the next generation is now coming of age; wealth is once again being passed on in China. The inheritors have been dubbed the fuerdai, which translates into the ‘rich second generation’. The highest-profile cases of wealth inequality are among the children of the super-rich. It’s not only the so-called princelings whose parents are Communist Party officials who are attracting attention. It’s also those such as Wang Jianlin’s son, Wang Sicong, who reveals his lifestyle on his microblog on Weibo, the Chinese version of Twitter. Whereas their parents tend to be frugal, the fuerdai, though they may work hard, play hard too. There is criticism in the media of their fast cars and extravagant spending. Their lavish lifestyles don’t sit comfortably in a society that still propounds the virtues of socialism. Wang Jianlin told me when I interviewed him for my BBC TV programme that, as societies become middle class, their resentment against the rich grows. He cited Singapore and Hong Kong as societies in which such attitudes have emerged as their societies became better off.

  His observation echoes studies that find that inequality and poverty are relative concepts. Indeed, it’s not just the absolute difference between the incomes of the rich and the poor that matters for wellbeing. That’s what is typically measured by indicators such as the Gini coefficient: an index that is zero if all individuals have the same income and one if one person has all the income in a country. But, as a society becomes increasingly dominated by a growing middle class, such comparisons are relative. In fact, in developed economies, it is income relative to the median income (the income of the middle person in the range of incomes) that defines poverty. By that gauge, nearly two million pensioners are poor in the UK when measured as those living on less than 60 per cent of the median income (measured as disposable income minus housing costs).

  For China, the shifting societal perceptions of inequality follow from its own recent transformation into a middle-class society. It was as recently as 2001 that per capita annual income in China exceeded $1,000, the level that defines the world’s poorest countries. It was only in 2010 that Chinese average incomes surpassed $4,000, the level that defines an upper-middle-income society. Even now, China occupies only a mid-table position in the league of countries ranked by average income.

  But, of course, the average obscures the distribution of income, and despite its communist system, the past decade or so has seen China become an unequal society. The top 5 per cent of households account for about a quarter of all income. There is a large gap between urban and rural incomes, or urban households earning three times as much as rural ones. The coast also outpaces the interior in terms of wealth. But the pattern of inequality is moderating. Income inequality reached a peak in 2008 and has since declined. Nonetheless, China, like other emerging nations, is a society that has become very unequal in many respects within a short period of time.

  Why has inequality risen over the past century?

  One of the reasons for high inequality in countries like China is that, as countries industrialize and urbanize, they grow more quickly. Those who move into industry and cities earn more than those who don’t, so income inequality tends to increase with economic development. But countries can reduce income inequality through redistributive policies. Without the social welfare system, inequality would be much higher in the US, the UK and much of the rest of Europe. The lack of such a well-established system is one of the factors contributing to China’s high levels of inequality.

  In developed countries, different forces are at work. First, globalization has pushed down median wages, and those who gain from international trade, namely the skilled workers and owners of capital, have earned more, while the middle- and lower-skilled have lost out in advanced economies. Another factor is something known as ‘skill-biased technical change’. As the economy becomes more technolo
gically driven, it’s again the most skilled workers who reap the greatest rewards. The two are related, of course.

  Thomas Piketty believes that inequality will rise when the returns to capital (r) exceed the growth rate of the economy (g). In this case, holders of capital (property, companies, stocks and so on) will see their incomes rise faster than average incomes in the long run.

  Others think differently. In France and Britain, for example, the value of private capital as a share of income has skyrocketed to over 500 per cent since the 1970s, while for the US that ratio is a hefty 400 per cent. As this wealth is passed along, the gap between the rich and the rest grows, so inherited wealth is another explanation for inequality. Paul Krugman has pointed out that around half of the wealthiest ten Americans inherited their wealth.

  Earned income is another driver of inequality. For instance, a CEO of America’s largest listed (S&P 500) companies earns, on average, over 200 times that of an average worker in the same company. In the 1960s, it was twenty times as much. Why has this happened? Former US Labor Secretary Robert Reich gives decreased unionization weakening the bargaining power over wages of workers as one cause.13

  It is likely that all these views have some merit, and that there are a number of factors that have contributed to growing inequality. Each of them suggests a different set of policy solutions. For instance, progressive taxes which tax the earnings of the rich at a higher rate than those of the poor would help to address some of the wage gap. If technological change is exacerbating inequality, then the fiscal system could be used to redistribute. That’s what the chairman of former US President Obama’s Council of Economic Advisers, Jason Furman, says they did. But others, including the founder of Bain Capital, Ed Conard, contend that raising taxes to reduce inequality is not a long-term solution and can harm companies.