On the reversal of fortune, urbanization and Canada

One of the more famous articles of economist Daron Acemoglu is his 2002 article on the reversal of fortunes where he points out that countries colonized by Europeans in 1500 that were relatively rich then are relatively poor now. In the paper, they use urban density as a proxy for economic development at that point in time.

I was not particularly convinced by this because of the issue of ruralization in colonial economies. I am still not convinced in fact. As many scholars interested in American colonial history point out, the country de-urbanized (ruralized) during the colonial era as cities grew at a slower pace than the general population. As such, the share of the US population in rural areas increased. But Jeffrey Williamson and Peter Lindert documented that in 1774, the United States were the richest place in the world (beating England on top of being more egalitarian). 

This is normal. Economies on the frontier had land to labor ratios that were the exact opposite of those in Europe. The opportunity cost of congregating in one area was high given the abundance of land that could be brought under cultivation. This is why the Americas (North America at least) was the Best Poor Man’s Country. As such, areas with low population density are not necessarily poor (even if urbanization is a pretty strong predictor of wealth).

This is where Canada comes in. Today, the country easily fits in the “relatively rich” group. According to the figures 1 and 2 in the work of Acemoglu, Johnson and Robinson, it would have been in the “relatively poor” group well behind countries in Latin America. However, I recently finished compiling the Canadian GDP figures between 1688 and 1790 which I can now compare with those of Arroyo Abad and Van Zanden for Peru and Mexico. With my Canadian data (see the figure below), we can see that Canada was as poor as Latin America around 1680 (the start date of my data).

GelosoGDP.png

So, Canada was a relatively poor country back which was equally poor (or moderately richer) than Latin American countries. Why does that matter to the reversal of fortune story? Well, with the urbanization data, one shows that the non-urbanized of 1500 are the rich of the today. With the GDP data for the 1680s, we see that the more urbanized countries were also poorer than the less urbanized countries.

Now, my argument is limited by the fact that I am using 1680s GDP rather than 1500 GDP. But, one should simply extend the urbanization series to circa 1700 and the issue is resolved.  In any case, this should fuel the skepticism towards the strength of the reversal of fortune argument.

Aggregate measures of well-being, England 1781-1850

I went in the field of economic history after I discovered how much it was to properly measure living standards. The issue that always interested me was how to “capture” the multidimensional nature of living standards. After all, what weight should we give to an extra year of life relative to the quality of that extra year (see all my stuff on Cuba)?

However, I never tried to create “a composite” measure of living standards. I thought that it was necessary, first, to get the measurements right. However, I had been aware of the work of Leandro Prados de la Escosura who has been doing considerable work on this in order to create composite measures (Leandro also influenced me on my Cuba reasoning – see this article).

A year ago, I discovered the work of Daniel Gallardo Albarrán from the University of Groningen at the meeting of the Economic History Society (EHS). Daniel’s work is particularly interesting because he is trying to generate a composite measure of well-being at one of the most important moment in history: the start of the British industrial revolution.

Because of its importance and some pieces of contradicting evidence (inequality, stature, amplitude of real wage increases, amplitude of income increases, urban pollution leading to increased mortality risks etc), the period has been begging for some form of composite measure to come along (at least a serious attempt at generating it). Drawing on some pretty straightforward microeconomic theory (the Beckerian in me likes this), Daniel generates this rich graph (see the paper here).

Daniel

The idea is very neat and I hope it will inspire some economic historians to attempt an expansion upon Daniel’s work. I have already drawn outlines for my own stuff on Canada since I study an era when (from the early 1800s to the mid-1850s) real wages and incomes seem to be going up but stature and mortality are either deteriorating or remaining stable while inequality is clearly increasing.

Household size and growth since 1870 (albeit in Canada)

Two days ago, I posted something on how much we were estimating growth since the 1950s. While organizing another research paper that I am trying to finish, I realized that I could make a follow-up to this based on previous research of mine.

A few months ago, I published (alongside Vadim Kufenko and Klaus Prettner) a short note in Economics Bulletin where we showed that the large differences in household size in Canada that existed up to 1975 led many to overestimate the level of differences between provinces. Moreover, we pointed out that because household size were converging at the same time as incomes, we argued that the rate of convergence from 1945 onwards was slightly overestimated. That paper convinced us to do the same between all the OECD countries (we are assembling the data right now).  But this was an argument about variance, what if we simply plot the “per capita” income of Canada with the “per adult equivalent” income of Canada since 1870.

By using the Maddison dataset combined with the data from my article, it took me a few seconds to get the graph below. What is important to notice in this graph is that, incomes per adult equivalent (measured in 1990 Geary-Kheamis dollars) have increased 40% less than incomes per person. Since adult equivalents are a better measure of living standards (because you capture the economies of scale associated with household size), we can easily say that we have been underestimating the level of improvement in Canada (it is still substantial however).

growthfactors

“Watch” the (industrial) revolution!

I don’t know how I missed such a valuable article, but O’Grada and Kelly have this fascinating piece on the price of watches in England from the early 18th century to the early 19th century in the Quarterly Journal of EconomicsStarting from Adam Smith’s quote that the price of watches had fallen 95% over roughly one hundred years, they collected prices of stolen watches reported in court records.  They find that Smith was wrong. The drop was only 75% (see the sarcasm here).

watch-prices

Why is this interesting? Because it shows something crucial about the industrial revolution. This was a complex good to build which required incredible technical advances – many of which could be considered general purpose technologies which could then be used by other industries for their own advances (on the assumption that other entrepreneurs noticed these technologies). But, more importantly, it provides further evidence against the pessimistic view of living standards in Britain at the beginning of the Industrial Revolution. These “new” goods became incredibly cheaper. Along with nails, glass, pottery and shipping , watches did not weigh heavily in the cost of living of the British. However, they did weigh heavily as industrial prices which meant that costs of production were falling progressively which augured well for the beginning of the industrial revolution*.

Literally, you can watch the industrial revolution in that paper! (sorry, bad pun)

* By the way, I use the term because it is conventional but a revolution is a clean break. The British industrial revolution was not saltation as much as it was a steady process of innovation from the early 18th century up to the mid 19th century. The real “revolution” in my eyes is that of the late 19th century. The technological changes from 1870 to 1890 are the most momentous in history and if there was any technological revolution in the past, this was it.

Did the Thirty Glorious Years Actually Exist?

Okay, I am going for a flashy title here. I should have asked whether the Thirty Glorious were as glorious as they are meant to be. This is a question that matters in debates about both inequality and the often-bemoaned growth slowdown.

In the past (say before 1950), labor force participation was quite low (relative to today) by virtue of large family sizes and most married women not working. However, when they were at-home, these married women produced something. That something was simply not included in our national accounts. When they entered the labor force, they produced less of that something. However, since it had never been measured, we never subtracted that something from the actual output generated from their increased participation.

Even before the 1950s, this mattered considerably as growth tended to be heavily underestimated (by 0.3 percentage points from 1870 to 1890, overestimated by 0.38 points from 1890 to 1910 and by 0.06 percentage points from 1910 to 1930).This was at a time when variations between the household economy and the market economy were small. Imagine the importance of overestimates since the 1950s! In a short comment reply to Emily Skarbek last year, I pointed out that adjusting for the size of the household economy meant that 1/7th of Canada’s economic growth from 1960 to 1997 (see image below and this was before one additional surge of labor participation resulting from daycare and unemployment policy reforms).

SEcularStagnation2

Recently, I found an old book in my library. It is Kenneth Boulding’s Structure of a Modern EconomyIn it, he makes this exact same argument. Basically, actual output today is overestimated relative to output in the past. And there are many, many, many other articles on this. In all cases, the rate of growth is heavily reduced. In a way, that means that the Thirty Glorious are less glorious (which makes the growth stagnation argument seem more defensible).

And you know what? This is consistent with attempts to correct inequality measures. Most of the attempts made to correct inequality for age, number of workers per household, the size of household and prices, they generally increase very modestly the income growth of the bottom centiles and decrease appreciably the actual level of growth of incomes at the top. While these corrections reduce the level of inequality (and the growth thereof), they also reduce the growth rate of incomes.

Is it possible that the correction to make inequality measures more comparable over time are allow us to see the point about overestimating growth since the 1950s? It means that the Thirty Glorious aren’t that glorious (at the very least, they’re overestimated). It also means that someone who could follow some of the proposed corrections to national income accounts (generally, the best source for this is the Review of Income and Wealth) for every year since 1929 (starting date of the US national accounts which could be extended by using Kuznets’s national income measures from 1913 to 1929) could propose the “actual output” of the country and see how glorious the 1945-1975 period was. That is the work of economic historians to do!

How much has Cuban productivity increased since 1960?

Is it possible for two equally rich countries (on a per capita basis) to have different level of output per worker? The answer is obviously yes, and it matters in the case of measuring growth in Cuba since the revolution.

A country with a very young population will tend to have fewer workers than one with an older (but not too old) population. Let’s say that countries A and B have a median age of 22.5 in year one.  However, in year ten, country A has a median age of 35 but country B has seen a more modest increase to a median age of 25. This will bias any estimates of growth comparison between both country. The increase in the median age suggests that there are more and more workers in country A (people of prime age) than in country B. As a result of that, output per capita will increase faster in country A than in country B even if both countries have equal rates of growth in output per worker.

Well, countries A and B are basically Cuba and most of the rest of Latin America. Since the 1950s, Cuba’s population has aged rapidly but birth rates have plummeted so fast that families shrunk. With fewer kids in the population, it means that the share of the Cuban population that are of prime working age increased rapidly. This is what biases the comparison of Cuban living standards with other Latin American countries.

In the figure below, I took the GDP (the Maddison data) of Cuba since 1950 (indexed at 1960 to see the arrival of Castro) and divided it by the total population, the population above 15 years of age and the population between 15 and 64.

cubagdp

As one can see, with the GDP per capita series, Cubans saw a 50% increase in their incomes between 1960 and 2005 (the Maddison data stops at 2008). However, when you look at GDP per working age adult in order to capture the growth in productive capacity, you get moderately different results whereby the cumulative increase is three-fifths to half as small.

In light of this, it seems like Cuba’s living standards are less and less impressive.

What is Wrong with Income Inequality? Five Reasons to be Concerned

I sometimes part ways with many of my libertarian and classical liberal friends in that I do have some amount of tentative concern for income/wealth inequality (for the purposes of this article, the otherwise important economic distinction between the two is not particularly relevant since the two are strongly correlated with each other). Many libertarians argue that inequality ultimately doesn’t matter. There is good reason to think this drawing from the classic arguments of Nozick and Hayek about how free exchange in a market economy can often interrupt preferred distributions.

The argument goes like this: take whatever your preferred distribution of income is, be it purely egalitarian or some sort of Rawlsian distribution such that the distribution benefits only the worst off in society. Assume there is one individual in the economy who has some product or service everyone wants to buy (in Nozick’s example it was Wilt Chamberlain playing basketball), and let everyone pay a relatively small amount of income to that one individual. For example, assume you have a society with 10,000 people all who start off with an equal endowment of $5 and all of them decide to pay Wilt Chamberlain $1 to watch him play basketball. Very few people would object to those individual exchanges, yet at the end Wilt Chamberlain ends up with $10,005 dollars and everyone else has $4, and our preferred distribution of income has been grossly upset even though the individual actions that led to that distribution are not objectionable. In other words, allowing for free exchange precludes trying to construct an optimal result of that free exchange (a basic consequence of recognizing spontaneous order).

Further, these libertarians argue, it is more important to ensure that the poor are better off in absolute terms than to ensure they are better off relative to their wealthier peers. Therefore, if a given policy will increase the wealth of the wealthiest by 10% and the poorest by 5%, there is no reason to oppose this policy on the grounds that it increases inequality because the poor are still made richer. Therefore, it is claimed, we should focus on policies that improve economic growth and the incomes of the poor and be indifferent as to its impact on relative inequality, since those policies are strongly correlated with bettering the economic conditions of the poor. In fact, as Mises Argued in Liberalism and the Classical Tradition, a certain amount of inequality is necessary for markets to function: they create a market for luxury goods that can be experimented and developed into future mass-consumption goods everyone can consume. Not everyone could afford, for an example, an IPod when it first came out, however today MP3 players are cheap and plentiful because the very wealthy were able to demand it when it was very expensive.

I agree with my libertarians in thinking that this argument is largely correct, however I do not think it proves, as Hayek argued, that social justice (understood in this context as distributive justice) is a “mirage” or that we should be altogether unconcerned with wealth or income distributions. All this argument does is mean that there is no overall deontological theory for an ideal income distribution, but there still might be good consequentialist reasons to think that excessively unequal distributions can impact many of the things that classical liberals tell us to worry about, such as the earnings of the poor, more free political economic outcomes, or overall economic growth. Further, even on Nozick’s entitlement theory of justice, we might oppose income inequality if it arises through unjust means. Here are five reasons why libertarians and classical liberals should be concerned about income inequality (note that they are mostly empirical reasons, not claims about the nature of justice):

1) Income Inequality as a Result of Rent Seeking

Certain government policies result in uneven income distribution. For an example, a paper by Patrick MacLaughlin and Lauren Stanley at the Mercatus Center empirically analyze the regressive effects of regulatory policy. Specifically, Stanley and MacLaughlin find that high barriers to entry create barriers to entry which worsens income mobility. Poorer would-be entrepreneurs cannot enter the market if they must, for an example, pay thousands of dollars for a license, or spend a large amount of time getting costly education and certifications to please some regulatory bureaucracy. This was admitted even by the Obama Administration in a recent report advising reform of occupational licensing laws. As basic public choice theory teaches, regulators are subject to regulatory capture, in which established business interests lobby regulators to erect barriers to entry to harm would-be competitors. Insofar as inequality is a result of such rent-seeking, libertarians have an obvious reason to oppose it.

Many other policies can worsen inequality. When wealthy corporations receive artificial monopolies from policies such as excessive intellectual property laws, insulating them from competition or when they gain wealth at the expense of poorer taxpayers through improper subsidies. When the government uses violent policing tactics to unequally enforce drug laws against poorer communities, or when it uses civil asset forfeiture to take the property of the worst off. When the government uses eminent domain to take the property of disadvantaged individuals and communities in the name of public works projects, or when they implement minimum wage laws that displace low-skilled workers. Or, if the structure of welfare benefits discourages income mobility, which also worsens inequality. There are a myriad of bad government policies which benefit the rich and exploit the poor, some of which are a direct result of rent-seeking on behalf of the wealthy.

If the rich are getting richer, or if the poor are stopped from becoming wealthier, as a result of government coercion, even Nozick’s entitlement theory of justice calls for us to be skeptical of the resulting income distribution. As Matt Zwolinski argues, income distributions are not only a result of, pace Nozick, a result of the free exchanges of individuals, but they are also a result of the institutions in which those individuals exchange. Insofar as inequality is a result of unjust institutions, we have good reason to call that inequality unjust.

Of course, that principle is still very hard to empirically apply. It is hard to tell how much of an unequal distribution is a function of bad institutions and how much is a function of free exchange. However, this means we can provide very limited theories of distributive justice not as constructivist attempts to mold market outcomes to our moral desires, but as rough rules of thumb. If it is true that unequal distributions are a function of bad institutions, then unequal distributions should cause us to re-evaluate those institutions.

2) Income Inequality and Government Exploitation
Of course, many with more Marxist inclinations will argue that any amount of economic inequality will inherently result in class-based exploitation. There are very good, stand-by classical liberal (and neoclassical economic) reasons to reject this as Marxian class analysis as it depends on a highly flawed labor theory of value. However, that does not mean there is not some correlation between some notion of macro-level exploitation of the worst-off and high levels of inequality which libertarians have good reason to be concerned about, for reasons closely related to rent-seeking. Those with a high amount of economic power, particularly in western democracies, are very likely to also have a strong influence over the policies set by the government. There is reason to fear that this will create a class of wealthy people who, through political rent-seeking channels discuss earlier, will control state policies and institutions to protect their interests and wealth at the expense of the worst-off in society. Using state coercion to protect oneself at the expense of others is, under any understanding of the term, coercion. In this way, income inequality can beget rent-seeking and regressive policies which lead to more income inequality which leads to more rent-seeking, leading to a vicious political-economic cycle of exploitation and increasing inequality. In fact, even early radical classical liberal economists applied theories of class analysis to this type of problem.

3) Inequality’s Impacts on Economic Growth

There is a robust amount of empirical literature suggesting that excessive income inequality can harm economic growth. How? The Economist explains:

Inequality could impair growth if those with low incomes suffer poor health and low productivity as a result, or if, as evidence suggests, the poor struggle to finance investments in education. Inequality could also threaten public confidence in growth-boosting policies like free trade, says Dani Rodrik of the Institute for Advanced Study in Princeton.

Of course, this is of special concern to consequentialist classical liberals who claim we should worry mostly about the betterment of the poor in absolute terms, since economic growth is strongly correlated with bettering living standards. There is even some reason for these classical liberals, given their stated normative reasons, to (at least in the short-term given that we have unjust institutions) support some limited redistributive policies, but only those that are implemented well and don’t worsen inequality or growth (such as a Negative Income Tax), insofar as it boosts growth and helps limited the growth of rent-seeking culture described with reasons one and two.

4) Inequality and Political Stability

There is further some evidence that income inequality increases political instability. If the poor perceive that current distributions are unjust (however wrong they may or may not be), they might have social discontent. In moderate scenarios, (as the Alsenia paper I linked to argue) this can lead to reduced investment, which aggravates third problem discussed earlier. In some scenarios, this can lead to support for populist demagogues (such as Trump or Bernie Sanders) who will implement bad policies that not only might harm the poor but also limit individual liberty in other important ways. In the most extreme scenarios (however unlikely, but still plausible), it can lead to all-out violent revolutions and warfare. At any rate, libertarians and classical liberals concerned with ensuring tranquility and freedom should be concerned if inequality increases.

5) Inequality and Social Mobility

More meritocratic-leaning libertarians might say we should be concerned about equal opportunities rather than equal outcomes. There is some evidence that the two are greatly linked. In particular, the so-called “Great Gatsby Curve,” which shows a negative relationship between economic mobility and income inequality. In other words, unequal outcomes can undermine unequal opportunities. This can be because higher inequality means unequal access to certain services, eg. Education, that can enable social mobility, or that the poorer may have fewer connections to better-paying opportunities because of their socio-economic status. Of course, there is likely some reverse causality here; institutions that limit social mobility (such as those discussed in problem one and two) can be said to worsen income mobility intergenerationally, leading to higher inequality in the future. Though teasing out the direction of causality empirically can be challenging, there is reason for concern here if one is concerned about social mobility.

The main point I’m getting at is nothing new: one need not be a radical leftist social egalitarian who thinks equal economic outcomes are necessarily the only moral outcomes to be concerned on some level with inequality. How one responds to inequality is empirically dependent on the causes of the problems, and we have some good reasons to think that more limited government is a good solution to unequal outcomes.

This is not to say inequality poses no problem for libertarians’ ideal political order: if it is the case that markets inherently beget problematic levels of inequality, as for example Thomas Piketty claims, then we might need to re-evaluate how we integrate markets. However, there is good reason to be skeptical of such claims (Thomas Piketty’s in particular are suspect). Even if we grant that markets by themselves do lead to levels of inequality that cause problems 3-5, we must not commit the Nirvana fallacy. We need to compare government’s aptitude at managing income distribution, which for well-worn public choice reasons outlined in problems one and two as well as a mammoth epistemic problem inherent in figuring out how much inequality is likely to lead to those problems, and compare it to the extent to which markets do generate those problems. It is possible (very likely, even) that even if markets are not perfect in the sense of ensuring distribution that does not have problematic political economic outcomes, the state attempting to correct these outcomes would only make things worse.

But that is a complex empirical research project which obviously can’t be solved in this short blog post, suffice it to say now that though libertarians are right to be skeptical of overarching moralistic outrage about rising levels of inequality, there are other very good empirical reasons to be concerned.