Introduction
Last week’s column sought to make it very clear that, in my view, Guyana’s burgeoning inequality and poverty are the direct products of decisions and collective choices made by the ruling cabal of politicians, controllers of criminal networks, economic and financial rogues, and other marauders, who as I have indicated, consider themselves not only ‘too big to jail’ but also destined by the gods to rule Guyana. Specifically inequality and poverty are not the unintended and unfortunate outcomes of blind economic and social forces.
I had also introduced the recent study of Thomas Piketty on income and wealth inequality (Capital in the 21st Century) in support of this view. I emphasized the revolutionary and paradigm-shifting nature of this study and promised that today I will present a simple and hopefully faithful summary of the analytic method at its core work. I strongly encourage readers to try and follow this simple rendition.
As indicated, Piketty’s work provides 1) a theoretical framework that deepens our appreciation of the mechanisms underlying the distribution of income and wealth; 2) in so doing encourages economic science “to return to the tradition of the broader political economy of Smith, Ricardo, Marx, Mill in economic analysis”; and 3) as a result “to show that if wealth is concentrated (and centralized) in fewer hands, it inexorably yields inequality.” The study focuses on the dynamics (laws of motion) driving the creation and distribution of income and wealth over the wide range of economies, which I indicated he has surveyed.
Classical political economy refers to the combined study of production, distribution, exchange and consumption of income and wealth in the market economy and economic sociology. Classical political economy also assumes competitive markets prevail, even though some authors (Marx in particular) predicted that over time competition would weaken, firms would grow larger, and monopoly increase. As a consequence two dynamic tendencies are predicted to emerge over time. One is that capital will become more concentrated, as individual capitalists increase the absolute size of the capital they control. And, the other will be redistribution in the ownership and control of existing capital, which will lead to its falling into fewer and fewer hands. This latter process is referred to as the centralization of capital. The resulting increase in firm size permits of economies of scale and therefore average costs to fall below those in smaller firms.
Capital and labour
Piketty utilizes standard mainstream neoclassical definitions of capital and labour. Both are defined in a productivity- related manner. Thus capital is constituted of those assets that generate returns, dependent on their productivities. Capital is a productive factor like labour and so earns competitive returns based on its productivity. Capital can take several forms including 1) physical capital, for example real estate, housing, infrastructure, buildings, farms, machinery and equipment, factories and so forth; 2) financial capital, for example stocks, shares, mortgages, bonds and other financial products; 3) intangible capital, for example proprietary brands, trademarks, patents, licences, royalties and so forth.
Since labour is also a productivity driven notion it refers to the physical and mental/intellectual effort individuals employ in the production of a country’s GDP. Labour therefore embodies skills, training and education of the workforce. Its returns take the form of wages, salaries and similar benefits.
These are the same definitions I had previously employed in the analysis of capital and labour’s share in Guyana’s GDP.
Two key relations
Piketty’s empirical analysis is based on two central economic relations (or equations). In their simplest formulations both are quite straightforward for the average reader to follow as shown in what follows.
First, if we examine capital carefully (as defined above) it is clear that its average rate of return is equal to the total value of all profits, dividends and rents received by its owners divided by the total value of the capital they collectively own. Let us call this rate of return, r. Here a simple example might help to make this statement even clearer. Let the total value of the capital be equal to $100 and the total value of the profits, dividends and rents, etc its owners receive equal to $7; then their rate of return is 7 divided by 100, which is 7 per cent (that is 7/100).
Based on the definition of capital given above, let us go one step further and term the share of national income (or GDP) it receives as a, and the ratio of capital to national income (or GDP) as B. Then equally we might state another obvious truism. That is the share of income from capital in the GDP or national income (that is a) is equal to the rate of return on capital (that is r) multiplied by the ratio of capital to GDP or national income (termed above B). This relation can thus be expressed as, a = r X B.
This relation is true by definition. It is what is called in second form algebra a basic identity. I have gone to the trouble of showing this to readers for the simple reason that in order to apply the analysis to any economy including Guyana (which I will attempt next week), one has to organize the available economic data into a model form of a set of equations from which to calculate this information as it is not otherwise available.
While one might say the first relation/equation given above tries to connect the stock of capital in an economy to the flows of income and capital in that economy, the second Piketty relation/ equation is a little more intriguing. It was introduced in order to identify the economic dataset from which the empirical analysis is to be conducted. Therefore, If we term the savings rate in the economy, s, and its rate of growth, g, and further recall that, B, is the ratio of capital to income or GDP then one can simply state that the ratio of capital to income, B, is equal to the rate of savings, s, divided by the rate of growth of GDP, g; that is, B = s/g.
Next week I shall wrap up this discussion by first looking at what the Guyana data reveal in this regard.
