Re­dis­tri­bu­tion or in­clu­sion? Fight­ing­forashare­ofthepie

Financial Mirror (Cyprus) - - FRONT PAGE -

The is­sue of ris­ing in­come in­equal­ity loomed large at this year’s World Eco­nomic Fo­rum in Davos. As is well known, the United States’ econ­omy has grown sig­nif­i­cantly over the past three decades, but the me­dian fam­ily’s in­come has not. The top 1% (in­deed, the top .01%) have cap­tured most of the gains, some­thing that so­ci­eties are un­likely to tol­er­ate for long.

Many fear that this is global phe­nom­e­non with sim­i­lar causes ev­ery­where, a key claim in Thomas Piketty’s cel­e­brated book Cap­i­tal in Twenty-First Cen­tury. But this propo­si­tion may be dan­ger­ously mis­lead­ing.

It is cru­cial to dis­tin­guish in­equal­ity in pro­duc­tiv­ity among firms from un­equal dis­tri­bu­tion of in­come within firms. The tra­di­tional battle be­tween labour and cap­i­tal has been about the lat­ter, with work­ers and own­ers fight­ing over their share of the pie. But there is sur­pris­ingly deep in­equal­ity in firms’ pro­duc­tiv­ity, which means that the size of the pie varies rad­i­cally. This is es­pe­cially true in de­vel­op­ing coun­tries, where it is com­mon to find dif­fer­ences in pro­duc­tiv­ity of a fac­tor of ten at the pro­vin­cial or state level and many times higher at the mu­nic­i­pal level.

Th­ese two very dif­fer­ent sources of in­equal­ity are of­ten con­flated, which pre­vents clear think­ing on ei­ther one. Both are re­lated to a sim­i­lar fea­ture of mod­ern pro­duc­tion: the fact that it re­quires many com­ple­men­tary in­puts. This in­cludes not only raw ma­te­ri­als and ma­chines, which can be shipped around, but also many spe­cialised labour skills, in­fra­struc­ture, and rules, which

a can­not be moved eas­ily and hence need to be spa­tially col­lo­cated. A short­age of any of th­ese in­puts can have dis­as­trous ef­fects on pro­duc­tiv­ity.

This com­ple­men­tar­ity makes many parts of the de­vel­op­ing world un­suit­able for mod­ern pro­duc­tion, be­cause key in­puts are miss­ing. Even within cities, poor ar­eas are so dis­con­nected and in­ad­e­quately en­dowed that pro­duc­tiv­ity is dis­mal. As a re­sult, there are huge dis­par­i­ties among firms in terms of ef­fi­ciency – and hence in the in­come they can dis­trib­ute.

Given pro­duc­tiv­ity con­straints, re­dis­tri­bu­tion is only pal­lia­tive, not cu­ra­tive. To ad­dress the prob­lem re­quires in­vest­ing in in­clu­sion, en­dow­ing peo­ple with skills, and con­nect­ing them to the in­puts and net­works that can make them pro­duc­tive.

The dilemma is that poor coun­tries lack the means to connect all places to all in­puts. They are faced with the choice of con­nect­ing a few places to most in­puts and get­ting high pro­duc­tiv­ity there, or putting some of the in­puts in all places and get­ting very lit­tle pro­duc­tiv­ity growth ev­ery­where. That is why devel­op­ment tends to be un­equal.

The other prob­lem of mod­ern pro­duc­tion is how to dis­trib­ute the in­come gen­er­ated by all of the com­ple­men­tary in­puts. To­day, pro­duc­tion is car­ried out not just by in­di­vid­u­als, or even by teams of peo­ple within firms, but also by teams of firms, or value chains. Just look at the cred­its at the end of any con­tem­po­rary film. Com­ple­men­tar­ity thus cre­ates a prob­lem of at­tri­bu­tion. How should credit for the fi­nal prod­uct be al­lo­cated, and to whom?

Econ­o­mists have tra­di­tion­ally be­lieved that each team mem­ber is paid her op­por­tu­nity cost, that is, the high­est in­come she could re­ceive if she were kicked off the team. In this con­text, if mar­kets are characterised by what econ­o­mists call per­fect com­pe­ti­tion, once the op­por­tu­nity cost of all in­puts has been paid, there is noth­ing left to dis­trib­ute. But in real life, the team is worth more – of­ten much more – than the op­por­tu­nity cost of its mem­bers.

Who gets to pocket this “team sur­plus”? Tra­di­tion­ally, the as­sump­tion has been that it ac­crues to share­hold­ers. But the rise of ex­treme C E O com­pen­sa­tion in the US, doc­u­mented by Piketty and oth­ers, may re­flect CEOs’ abil­ity to dis­rupt the team if they do not get part of the sur­plus. Af­ter all, CEOs ex­pe­ri­ence pre­cip­i­tous in­come de­clines when they are kicked out, in­di­cat­ing that they were paid far more than their op­por­tu­nity cost.

In the case of suc­cess­ful start-ups, the money paid when they are ac­quired or go public ac­crues to those who put the team to­gether. For more con­ven­tional value chains, the sur­plus tends to go to the in­puts that have greater mar­ket power. Busi­ness schools teach their stu­dents to cap­ture the max­i­mum sur­plus in the value chain by fo­cus­ing on in­puts that are dif­fi­cult for oth­ers to pro­vide while en­sur­ing that other in­puts are “com­modi­tised” and hence can­not cap­ture more than their op­por­tu­nity cost.

The

gains do

not

ac­crue

to

the most de­serv­ing. The rise of “cap­i­tal,” which Piketty doc­u­ments in France and other coun­tries, is caused mostly by the ap­pre­ci­a­tion of real es­tate, sim­ply be­cause good lo­ca­tions be­come more valu­able in an in­creas­ingly net­worked econ­omy. As with land, the cur­rent in­tel­lec­tual prop­erty-rights regime, by over-pro­tect­ing old ideas, may pro­vide mar­ket power that not only ex­ac­er­bates in­come in­equal­ity but also hurts in­no­va­tion.

This means that poli­cies aimed at en­sur­ing an eq­ui­table out­come should rely on ei­ther own­ing or tax­ing the in­puts that cap­ture the “team sur­plus.” One rea­son why Sin­ga­pore has a well-funded gov­ern­ment, de­spite low taxes, is that its suc­cess­ful poli­cies caused the land and real es­tate it owned to ex­plode in value, gen­er­at­ing a huge rev­enue stream.

Sim­i­larly, the Colom­bian city of Medellin funds it­self from the prof­its of its suc­cess­ful util­ity com­pany, which is now a multi­na­tional player. The econ­o­mist Dani Ro­drik re­cently sug­gested that gov­ern­ments should fund them­selves from the div­i­dends earned by in­vest­ing in public ven­ture funds, thus so­cial­is­ing the gains from in­no­va­tion.

Of course, cap­tur­ing this sur­plus may al­low for in­come re­dis­tri­bu­tion, as many sug­gest; but a much big­ger and sus­tain­able bang can be achieved if the pro­ceeds go in­stead to fi­nanc­ing in­clu­sion. In the end, in­clu­sive growth may gen­er­ate a more pros­per­ous and egal­i­tar­ian so­ci­ety, whereas re­dis­tri­bu­tion may fail to ben­e­fit ei­ther in­clu­sion or growth.

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