Finding a New Macroeconomics: (4) A Georgist-Keynesian Synthesis

We scarcely have time to congratulate ourselves on [the victory of market economics over socialism] before confronting failures like the growing concentration of economic power, growing inequality of income and especially wealth, stagnant or falling real wage rates, homelessness and beggary, chronic unemployment, growing crime rates and personal insecurity, low domestic capital formation, obsolescence in the face of rising foreign competition, dangerous dependence on foreign oil, growing recourse to the underground economy, falling literacy and educational attainments, anomie and substance addiction, rampant self-seeking and predation, falling affordability of housing, and rising social divisions leading toward class warfare.

The thesis here is that the structural flaw in capitalism is our tolerance of unearned income and wealth. The idea of free markets is that income should go to incite and reward productive activity; wealth should incite and reward saving and capital formation. Unearned income and wealth do neither. Unearned wealth today (like slave-owning in the past) actually deters saving by the fairly obvious route of satisfying the owners’ need for the security of wealth, without their actually creating any capital. – Mason Gaffney [1] 

The above recitation of capitalist “failures” by the renowned Georgist economist Mason Gaffney emphasizes the interconnection between the “growing inequality of income and especially wealth” in America and its worsening depression-like economic woes. The last post showed that over the last thirty years U.S. income has become increasingly concentrated high in the top 1%, and that the growth of income inequality has been continuous and accelerating.  It has been a broad-based trend, with income concentration growing in all sectors of the economy, especially the business and corporate sectors. Although this trend encompasses both labor and capital income, the highest concentration growth has been in capital and business income. This indicates a broad-based transfer of income and wealth to the top 1% in the normal operation of the economy, a redistribution coming mainly from an increase in corporate profits; and the data show that, although both factors are at work, the higher profits and consequent inequality are generated more by the exercise of market power to generate “unearned income and wealth” than from direct suppression of labor’s share.

The core “Keynesian” factor in the mechanism of this inequality growth identified earlier is what we used to call, back in the 1960s, the “consumption function;” this is the expression of one of Keynes’s three independent variables, the propensity to consume. However, it is not the aggregate consumption function — that is, the overall economy-wide propensity to consume — with which we are concerned: When income and wealth are redistributed to the top, as discussed in the last post, it is the materially lower marginal propensity to consume from very large incomes that drives depressed growth and contraction, and that is the major source of instability and contraction in market economies. With the new distributed income data, economists can now develop distributed propensity to consume data and distributed consumption functions, although so far as I am aware none have yet done so.  

The other core aspect of inequality growth is the removal of this redistributed income from the active economy, to be salted away as idle savings without adding to the level of production. This is where the second part of the Gaffney quotation gets to the heart of the matter: What Gaffney calls “unearned income and wealth” — i.e., money acquired beyond the amount actually needed for the provision of productive activity and capital formation — provides a near-perfect explanation of the mechanism of growing inequality.  Put another way, it is money redistributed to the top in excess of the incremental production of real value. In fact, I will venture to argue that the accumulation of “unearned income and wealth” is the inequality problem; buyers are continuously receiving insufficient real value in exchange for their money, and losing ground relative to sellers; the result is a combination of reduced  production of real value and contraction of the active money supply.  

“Political and Social” Explanations

The public and professional discussion so far about the causes of inequality  has focused mostly on “the declining labor share,” including, “changes in technology, increasing globalization, changes in market structure, and the declining negotiating power of labor.” [2] These are all aspects of the decline but, as Stiglitz puts it, the identification of such proximate causes is mostly “beside the point.” [3] Focusing on such social and structural problems is not inappropriate, but that focus distracts from an understanding of the underlying mechanism of inequality growth, which is independent of its manifestations.  

Similarly beside the point is the argument that the sudden explosion of CEO pay relative to the incomes of typical employees relates to political and social acceptability of raising executive compensation.  Paul Krugman, as noted earlier, has argued that the growth of inequality should be thought of as mainly a “political” phenomenon:

Thomas Piketty and Emmanuel Saez, whose work I’ve already mentioned, have argued that top incomes are strongly affected by social norms.  * * * [That argument suggests] that changes in the political climate after 1980 may have cleared the way for the raw exercise of power to claim high incomes, in a way that wasn’t considered doable earlier. It’s surely relevant here to note the sharp decline in unionization during the 1980s, which removed one player that might have protested huge paychecks for executives. [4]     

With all due respect to these major players in the economic debates, this logic seems unrealistic: How often have American CEOs whose corporations are greatly increasing their profits actually not considered it “doable” to give themselves substantial raises?  And how often do they decline to give themselves raises even when company earnings are declining?  More importantly, it invites inattention to (or even dismissal of) the underlying question of how changing income distribution affects aggregate income growth; the perspective nicely mirrors the characterization Keynes made of the distribution of wealth and incomes as “arbitrary” when he created a full employment model without accounting for redistribution.  

We should be looking for such social and political explanations for the skyrocketing levels of CEO compensation only if changing levels of executives’ compensation do not affect the amount they spend and save, and the amount left over for everyone else to spend and save; that is, only if income and wealth distribution lack macroeconomic significance. But that is not the case. Recall what Keynes said about the difficulty of shedding the old ideas of classical economics that he challenged: “The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.” [5] Today, many mainstream Keynesian economists appear to be facing this same difficulty in dislodging the presumption built into Keynes’s General Theory that wealth and income distribution, somehow, lack economic significance. 

Such “social and political” arguments also ignore the extreme and so far successful opposition of the very wealthy in the United States to paying higher taxes on whatever they do decide to pay themselves. The better argument seems to be that their corporations are making too much money and that these top executives are, as best they can (with perhaps a few exceptions), keeping as much of these excess earnings as possible. The following chart of major countries, plotting their top 1% income share against their top marginal tax rate in 2004-2008, was published by Piketty and Saez themselves: [6]   

Pages from DP8675 (1) - picketty saez

Compared with top executives in other countries, this chart shows that in the years leading up to the Crash of 2008, the wealthy elite in the United States better overcame whatever reservations they might have had about increasing their incomes, and they succeeded more than the wealthy in those other countries in minimizing their marginal income tax rate (and hence their effective tax obligations).

The Reagan Revolution

The political and social factors affecting executive compensation and the institutional factors affecting labor’s share are certainly real, but I suggest we think of them as “secondary causes” — i.e., factors that come into play only as a consequence of, or independent of, these “primary causes” of increasing inequality and declining growth and prosperity. The 30-year decline in growth and prosperity was the direct result of two broad policy initiatives initiated during the Reagan Administration:

(1) Deregulation of business and finance, which allowed corporations to increase their profits and the wealthiest Americans to increase their incomes; and

(2) Reduced taxes on top household incomes and corporate earnings, which allowed the wealthiest Americans to keep a greater share of their higher incomes and accumulate greater wealth.

Certainly no set of policies could have been better designed to maximize inequality growth and minimize overall income (GDP) growth.  The next post will focus on taxation, and the balance of this post will focus on the elusive concept of “excess profit” or excess return to capital, a.k.a. “unearned income.”

“Unearned” Income and Wealth

How do we know when the wealthiest people are making and keeping too much money? When the time came to discuss that issue, Keynes offered only this:

For my own part, I believe that there is social and psychological justification for significant inequalities of incomes and wealth, but not for such large disparities as exist today. There are valuable human activities which require the motive of money-making and the environment of private wealth-ownership for their full fruition. * * * It is better that a man should tyrannize over his bank balance than over his fellow-citizens; and whilst the former is sometimes denounced as being but a means to the latter, sometimes at least it is an alternative. But it is not necessary for the stimulation of these activities and the satisfaction of these proclivities that the game should be played for such high stakes as at present. Much lower stakes will serve the purpose equally well, as soon as the players are accustomed to them. [7]

Beyond rejecting Marxist socialism, Keynes found no way to identify what might be a low enough level of inequality to allow motivation of innovation and growth, and what would be too much inequality. His statement is reminiscent of the famous comment by Justice Potter Stewart in a concurring opinion in a 1964 obscenity case: “I know it when I see it.” [8]    

Today, with the income distribution of a century available, we can now do better than that. We have already seen that when inequality becomes too great, the economy is driven into a depression and everyone, except for the hyper-rich, are doing worse.  Disparities as great as that are clearly unacceptable.  A more precise standard lies in the concept of “economic rent,” which consists of payments for which no new value is created, including all unearned income and excess profits.  Stiglitz identifies the connection between economic rent and inequality:

[M]uch of the inequality in our economy was the result of rent seeking. In their simplest form, rents are just redistributions from the rest of us to the rent seekers.* * What is striking is the prevalence of limited competition and rent seeking in so many key sectors of the economy. [9]

Stiglitz’s new book is the first to broadly associate inequality growth with economic rent since the American economist Henry George published Progress and Poverty in 1879, two depressions and 133 years earlier.  George observed that “current political economy cannot explain why poverty persists in the midst of increasing wealth,” [10] George’s perceptive insight that the collection of “unearned” returns creates inequality provides a crucial factor still missing from mainstream theory:  Transfers of economic rent to the top converts money that could otherwise be used for productive activity into idle wealth.  When money (e.g., the unearned income of hedge fund managers) is redistributed upward without producing new value, resources are idled and growth is retarded.  Stiglitz elaborates:

To put it baldly, there are two ways to become wealthy: to create wealth or to take wealth away from others. The former adds to society. The latter typically subtracts from it, for in the process of taking it away, wealth gets destroyed. A monopolist who overcharges for his product takes money from those whom he is overcharging and at the same time destroys value. To get his monopoly price, he has to restrict production. * * * Today, over a century after the railroad barons dominated the economy, much of the wealth at the top in the United States – and some of the suffering at the bottom – stems from wealth transfers instead of wealth creation. [11]

If we define “excess earnings” as “profit” — i.e, all payments for goods and services in excess of their cost — then all excess earnings are economic rent.  Given that the primary objective of most corporations in a capitalist, market-based economy is to maximize profit, the objective of capitalism in effect is to maximize economic rent.  Thus, it is the profit motive that makes instability and decline basic features, as we have been discussing, built into the capitalist market system.  

Expanding Market Power

Since 1980, excess earnings have been enabled and expanded throughout the economy by lax anti-trust law enforcement, relaxed essential industry and financial transaction regulation, control of government contracting, and a new corporate culture that values financial gain over productivity and employment. These developments are well documented. [12] Barry Lynn gives a typical example of one of the most important trends, the concentration of market power in mega-corporations like Exxon Mobil, General Electric, Monsanto or Walmart:

Until we elected Ronald Reagan president, both Democrats and Republicans made sure that no chain store ever came to dominate more than a small fraction of sales in the United States as a whole, or even in any one region of the country.  Between 1917 and 1979, for instance, administrations from both parties repeatedly charged the Great Atlantic and Pacific Tea Company, the chain store behemoth of the mid-twentieth century that is better known as A&P, with violations of antitrust law, even threatening to break the firm into pieces.  Then in 1981 we stopped enforcing that law.  Thus, today Wal-Mart is at least five times bigger, relative to the overall size of the U.S. economy, than A&P was at the very height of its power (citation). Indeed, Wal-Mart exercises a de facto monopoly in many smaller cities, and it sells as much as half of all the groceries in many big metropolitan markets. [13]

The assumptions of classical economics that ensure a supply price for any product or service equal to its cost (i.e., there is no profit) are perfect competition and perfect knowledge.  These are the conditions necessary for absolutely efficient markets.  Of course, these conditions have never been met in the real world, and there are many things capitalist firms can do to thwart market efficiencies, enabling them to charge above-cost prices.    

One important point of intersection of Georgist and Keynesian theory lies with the “cost of capital,” a concept that has for decades been implicit in my profession, utility rate regulation.  Rate regulation is intended to provide a substitute for competition in the case of providers of essential services like telephone, natural gas, electric or water services. These are industries where monopolistic market power could easily produce excess earnings, if the firms are allowed to charge whatever they wish for the essential services they provide. Rates are set to include all of a company’s reasonable costs, including their costs of capital.  

Any excess of earnings above a regulated firm’s cost of capital would be “excess profit,” i.e., economic rent, and for decades in the U.S., monopoly providers of regulated services have been allowed to charge rates that would allow no more than a reasonable opportunity to achieve earnings sufficient to attract equity capital in the financial markets – i.e., to earn their “cost of capital,” or the “fair rate of return” — while providing high quality service. This cost of capital is equivalent to one of the three independent variables in Keynes’s model — the “marginal efficiency of capital.” It is, in theory, the present value of all expected future returns on the common stock of regulated firms, and it is the cost of capital Keynes identified, across an entire economy, for full employment and growth.  

In a “rate case” the monopoly provider of regulated service justifies all of its costs, including labor and management compensation. Federal and state commissions charged with rate regulation have designed rates to allow for reasonable levels of executive and management compensation as part of the cost of providing good service.  Firms charging regulated rates can contribute to income inequality in their actual operation, however, by increasing executive compensation while cutting back on other operating costs.  It appears that the effectiveness of rate regulation has declined in recent years in this respect; for example, in the case of electric service:

Over a decade of deregulation, the frequency and duration of outages has crept up, maintenance of aging infrastructure has been deferred, line workers have been laid off — and CEOs’ salaries have risen an average of 150 percent nationwide, a Hearst Newspapers investigation has found. [14]

However ineffective the laws designed to promote competition and the minimization of monopolistic market power (anti-trust laws), or reasonable prices for service provided by natural monopolies (rate regulation) may have recently become, they do at least provide theoretical benchmarks for avoiding the severe growth of inequality witnessed in the United States over the last three decades.

Wealth Transfers

It is difficult to estimate the amount of wealth that has transferred to the top over the last 30 years.  The data provided by Edward N. Wolff, a leading authority on U.S. wealth distribution, [15] shows not only that wealth inequality was considerably higher than income inequality in 2007, but that the concentration of wealth at the top has not changed much over the last 30 years:

Top 1% Share

                    Year                                             Income             Net Worth     Non-Home Wealth                                        

                1983 (1982 for income)              12.8%                   33.8%                   42.9%

                2007 (2006 for income)            21.3%                   34.6%                   42.7%          

                2010                                                                            35.5%                   42.1%  

At the beginning of the Reagan Administration, significant income and wealth concentration already existed in the United States, and the top 1% owned about 43% of financial (non-home) wealth.  The concentration of reported wealth did not change much thereafter, despite a near doubling of the top 1% share of income.  The question arises, with the top 1% income concentration nearly doubling, why hasn’t wealth concentration increased noticeably?  

One part of the answer may be that because net worth is much greater than GDP (nearly four times larger in 2010), its rate of change in response to income inequality should be much lower; note, however, that since the Crash of 2008 U.S. wealth inequality data has begun to show some material growth. Another part of the answer appears to be that much of U.S. top 1% wealth in recent years is not reflected in these data because it is held in “offshore” accounts, a matter that in 2012 began to attract a great deal of new attention. [16] Thomas Piketty has observed: 

So far, we have not taken this (offshore money) into account in the World Top Incomes database.  We tried always to be very clear that [our results are] certainly a lower bound, not only for the level of inequality, but probably for the trend as well. [17]

This important topic needs more attention.

Conservatively assuming that the top 1% share of net worth has been a constant 34% (although according to the Wolff data it rose to 37-38% from the mid-1980s to the late 1990s), using Census Bureau net worth data and the GDP deflator provided by St. Louis Fed. Research, I have computed that the top 1% share of net worth, in 2010 dollars, grew about $11.8 trillion from 1982 to 2010.  According to census data, there were about 306 million people in 2010 in the bottom 99% of the U.S. population.  In 2010 dollars, this works out to a transfer from the bottom 99% to the top 1% of about $38,560 per capita. That’s nearly $1,400 annually of per capita economic rent, or “excess earnings,” going to the top 1%.


Governments in the U.S. cannot regulate the rates of all monopolies or near-monopolies, and it is impossible to prevent the taking of “excess earnings.”  The amount of reported wealth transfers to the top 1% since 1980 is startling and, quite frankly, sobering. This enormous redistribution of wealth from the bottom 99% has already caused substantial damage, and the process continues. The ultimate and crucial question is this: What are the basic income and wealth distribution requirements for U. S. survival? Fortunately, a market-based society can regulate the amount of excess earnings it allows the wealthy to keep: It can tax them back down.  But it must have the intelligence, and the will, to do so.

JMH – 5/8/2013  


[1] “’Capital’ Gains and the Future of Free Enterprise,” by Mason Gaffney, Workpapers, rev. December, 1991 (here).

[2] The 2013 Economic Report of the President, p. 60 (here).

[3] Joseph E. Stiglitz, The Price of Inequality: How Today’s Divided Society Endangers Our Future, New York and London, W. W. Norton & Company, 2012, pp. 79-80.

[4] Paul Krugman, End This Depression Now!,  W.W. Norton & Company, NY (2012) pp. 81-82.

[5] John Maynard Keynes, The General Theory of Employment, Interest, and Money, 1935, New York and London, Harvest/Harcourt, Inc., 1953, 1964 ed., 1991 printing, Preface, p. viii.

[6] “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” by Thomas Piketty,  Emmanuel Saez, and Stefanie Stantcheva, , DP No. 8675  (CEPR, November, 2011) (here), p. 50.

[7] The General Theory, supra, p. 374.

[8] Concurring Opinion in Jocobellis v. Ohio, 378 U.S. 184 (1964).

[9] The Price of Inequality, supra, pp.96-97.

[10] Henry George, Progress and Poverty, San Francisco 1879, Bob Drake, editor,  the Robert Schalkenbach Foundation, Fourth Edition, New York 2006, p. 28.

[11] The Price of Inequality, supra, p 32.

[12] See, e.g., Nomi Prins, It Takes a Pillage, John Wiley & Sons, NJ (2009); Jacob S. Hacker and Paul Pierson, Winner-Take-All Politics, Simon & Schuster, NY (2010); Barry C. Lynn, Cornered: The New Monopoly Capitalism and the Economics of Destruction, Wiley & Sons, NJ (2010); see also David Cay Johnston, The Fine Print, Penguin Group, NY (2012), and Free Lunch, Penguin Group, NY (2007).

[13] Cornered, supra, p. 6.

[14] “An industry in disconnect,” by Eric Nalder , Albany Times Union, January 13, 2012 (here).

[15] “Recent Trends in Household Wealth in the United States: Rising Debt and the Middle-Class Squeeze – an Update to 2007,” by Edward N. Wolff, Working Paper No. 589, Levy Economics Institute of Bard College, March 2010, p. 3 (here); 2010 data reported in “Wealth, Income and Power,” by G. William Dumhoff (here).

[16] See, e.g., “The Price of Offshore Revisited: New Estimates for Missing Global Private Wealth, Income, Inequality, and lost taxes,”  by James S. Henry, the Tax Justice Network, 2012 (here) and “Wealth doesn’t trickle down  – it just floods offshore, research reveals,” by Heather Stewart, The Observer, July 21, 2012 (here); Paul Buchheit argues from the TJN study that an estimated $8-12 trillion of U.S. money could be “stashed in far-off hiding places” — “Ten Numbers the Rich Would Like Fudged,” by Paul Buchheit, Common Dreams, November 19, 2012 (here).

[17] “Inequality: You Don’t Know the Half of It,” by Nicholas Shaxson, John Christensen and Nick Mathiason, The Tax Justce Network, July 22, 2012, pp. 10-11 (here).

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