October 11, 2012

Distribution and Labor

What we refer to abstractly as "the economy" can be understood as (at the very least) two distinct but intimately connected systems: a system of production, and a system of distribution. The system of production includes not only the proverbial "making of things" but the doing of things that makes the making of things easier, and also the doing of things that makes doing things we want to do for their own sake easier. The system of distribution refers to all of the exchanges that do or could take place in an economy and way those exchanges work.

Since at least the advent of industrialization, our economies have had the somewhat counterintuitive problem of functioning better as systems of production that as systems of distribution. This is counterintuitive because if we see scarcity as the fundamental economic problem, distribution would appear to take on a secondary importance. Unfortunately, abundance is irrelevant if it is concentrated in the hands of a few people; good distribution is therefore of paramount importance as well.

However, it is important to understand what we mean when we talk about "good" distribution systems. We can imagine an ideal distribution system that distributes value (resources or money) exactly in proportion to the value provided by a person to society. A different ideal distribution system would distribute production equally among everyone. We can also evaluate distribution systems purely in terms of costs, where a costless distribution system would be the ideal.

Good distribution is important for a number of reasons. There is a substantial, purely moral argument to be made for a degree of distributive equality if we believe it is fair and right. There is also a moral argument to be made for some degree of merit-based distribution. There are political arguments, for example the argument that mass democracies require a sizable middle class. And there are utilitarian arguments from a purely economic standpoint: e.g., that being rewarded for work is an important incentive, or that an economy based on mass production requires a mass base of consumers.

Up to now, when talking about distribution I have been conflating consumption and production, which has made things somewhat awkward to think about. As I explained it in the first paragraph, distribution involves exchange, which means things are going both ways. Generally we do a reasonably good job of distribution in consumption markets--that is, selling products. What is becoming more and more a problem is distribution in production markets--that is, selling labor and capital.

Our economy today has two major means of distribution on the production side: labor and capital. Or at least, this is the common distinction economists use between money that flows to workers and money that flows to capital owners. Historically, the balance between labor income and capital income in the USA and most developed countries has been around 70% for labor and 30% for capital, meaning that 70% of the money going to people in our economy was through wages and 30% was through investment income.

The 70-30 split does not have any special significance. Depending on the amount of workers getting paid and the number of investors making money from investments, you can get significantly different distributional outcomes from a constant labor/capital ratio. The importance of pension funds are an excellent example of this, because they distribute investment income to (former) workers.

Still, the 70-30 split has been a fairly stable historical trend, and as such can tell us interesting things about the economy. Perhaps most importantly, it reminds us that our economy is based on jobs. This fact is not news to anyone, of course, but even amidst weekly unemployment estimates and constant campaign rhetoric we can easily forget the fundamental importance of labor for distributing wealth: labor income is perhaps the most important category of exchanges in our economy.

This assumption is so deeply embedded in our worldview that we take it for granted, even though it is something of a historical anomaly and appears to now be changing dramatically.

The prevalent view among current policymakers is that employment is best created by creating business-friendly conditions and then leaving markets to do their own thing--perhaps with some help for infant industries (e.g. green technology) and a few safeguards to cushion unemployment, if you are a liberal. What does it mean, though, that employers have been paying their employees a significantly smaller portion of income? If we can no longer expect labor income to stay within a certain range, what does that mean for our expectations of full or nearly-full employment? Even if we assume full employment (if workers choose not work, for example), what does it imply for society if only 50% of business income is routed to labor? Only 30%? Clearly we would be looking at a vastly different world. Could we transition to an economy that is not based on labor income? Or should we expect labor income to recover?

Stay tuned.

1 comment:

  1. Does it look to you as if labor's income share rises leading up to each recession, peaks coincident with the recession, and then declines sharply after? Or am I looking at the graphical representation of the data in the Cleveland Fed paper with major selection bias?