Why not Keynes? Keynes’ uneasy relationship with income distribution

 

I was asked several times, and most recently only a couple days ago, why in Visions of Inequality I do not discuss Keynes. He doesn't have a chapter like the other six authors and when I mention Keynes it is only in passing and simply in relationship to the marginal propensity to consume. My answer is twofold. First,  I think that Keynes was not interested in income distribution. And, more importantly, at one point where he clearly could have, or even should have, brought income distribution into discussion he declined to do so and decided to ignore it.

It is all tacitly assumed throughout The General Theory that the functional income distribution (labor share In total output) is unchanged. Keynes believed, or pretended to believe, in the so-called Bowley’s law, a relative fixity of labor and capital shares, found to have existed in Britain over the first two decades of the 20^th century. The fact that “the law” applied to only one country and held for a short period of time did not seem to have bothered Keynes. This in turn meant that Keynes believed that interpersonal income inequality was also fixed. If both functional and interpersonal inequalities are fixed, there is no need to discuss income distribution, and Keynes indeed does not discuss it at all.

The second reason is more interesting and to some extent more dramatic. It illustrates what I believe was Keynes’s politically-induced unwillingness to bring income distribution into The General Theory.  

It is well known that the lack of effective demand, the main topic of the book, arises from the fact that consumption and private investments are not necessarily equal to the aggregate supply. As Keynes writes, total consumption increases only as a fraction of the increase in aggregate output. That means that the shortfall between the two (aggregate supply on one hand, and aggregate consumption on the other) has to be filled in by private investments. It is only in a special case that the desired private investments will be exactly equal to that gap. But when investments fall short of it, government spending has to be brought in to increase the effective demand and to balance supply and demand (at a given level of employment). 

Even a very cursory look at the fundamental equation which is A  (aggregate supply) = C + I + G shows that if C (aggregate consumption) is a function of income distribution an obvious way to rebalance supply and demand is to “improve” income distribution, that is to transfer purchasing power from the rich to the poor. If $1 is transferred from a rich person who normally consumes only 50 cents, to a poor person who would consume 95 cents, aggregate consumption will increase. One  can then fine-tune it until it closes the gap between the aggregate supply and the effective/aggregate demand. There is no need to introduce government spending, G.

The question is then, why was such an obvious path out of insufficient demand not taken by Keynes?  He had in front of him two possibilities: one was to increase government spending; the second was to redistribute income towards the poor. The latter is an easier solution and entirely within the logic of the model itself, including within the logic of a new concept of “propensity to consume” which Keynes has introduced. But if income distribution is assumed unchanged or unchangeable, or if one does not want to touch income distribution for political reasons, then the only way out is the one taken by Keynes: increased government spending.

It is remarkable that in the entire General Theory income distribution plays absolutely no role at all. When Keynes discusses the forces that affect aggregate propensity to consume he lists no fewer than fourteen: six of them “objective”, eight  “subjective”. Just to give an idea what are the forces that affect consumption, here is a list: among the objective factors: (i) change in wage units (i.e., change in real income), (b)  change in the difference between net income and income, (c) windfall changes in capital values, (d) change in the rate of discount, (e) change in fiscal policy, (f) change in the expected relation between present and future level of income; as for the psychological causes, they are (a) to build a reserve against unforeseen contingencies, (b) to provide for an anticipated future relation between income and  the needs of an individual and his family different from which  exists at the present, (c) to enjoy interest and appreciation, (d) to enjoy a gradually increasing expenditures, (e) to enjoy the sense of independence, (f) to enjoy a masse de maneuvre to carry out speculative or business projects, (g) to bequeath a fortune, (h) to satisfy pure miserliness. It is rather curious that among this plethora of causes, there was no place for income distribution.

That Keynes was aware that income distribution can affect propensity to consume is shown, very briefly and discreetly, in a couple of references in Chapter 22 (“Note on Trade Cycles”; importantly, the chapter is not in the main part of the book, but in “Short Notes Suggested by the General Theory”, rather sundry reflections stimulated by Keynes’ writing of the main  text), where Keynes writes: “I should readily concede that the wisest course is to advance on both fronts [increasing investments and consumption] at once. Whilst aiming at a socially controlled rate of investment with a view to a progressive decline in the marginal efficiency of capital, I should support at the same time all sorts of policies for increasing the propensity to consume. For it is unlikely that full employment can be maintained, whatever we may do about investment, with the existing propensity to consume. There is room, therefore, for both policies to operate together; — to promote investment and, at the same time, to promote consumption” (p. 325). Since this section opens with a clear discussion of “schools of thought” which “maintain that chronic tendency of contemporary societies to underemployment is to be traced to under-consumption;…that is to say…to a distribution of wealth which results in a propensity to consume which is unduly low (p. 324), it is clear that the increase in consumption that Keynes has in mind here comes from changed distribution of wealth or income. However, here too, he believes that working on increasing investments and, if needed, government spending, is more immediate and better (since investments result in augmentation of productive capacity) than altering distribution to increase consumption. This is the furthest that Keynes has come in the entire book to acknowledging a role for income distribution.

 All but universal omission of income distribution was quickly noted. In a 1937 article in The Review of Economics and Statistics, Hans Staehle shows how German wage distribution has changed in the period 1928-1934, and how it has affected consumption. He registers his disbelief that Keynes could have overlooked such an obviously potent force that affects aggregate propensity to consume and in turn effective demand. He writes:

it is obvious that any modification in the distribution of incomes entails a modification…so that the marginal propensity curve of the market can be derived from the individual curves…only on the assumption that the size-distribution of incomes is constant. Keynes has entirely overlooked this implication. He takes it that the derivative of the market function [of aggregate consumption] will have the same characteristics as that of any individual curve…Among the factors capable of shifting the market curve, he does not list changes in the size-distribution of incomes, but only mentions changes in the income distribution as between entrepreneurs and rentiers [and this very modestly and in passing]. But even this Keynes does not consider to be an important factor. The only other reference to the income-distribution in connection with the propensity to consume is in the chapter on the trade cycle, where the "redistribution" of incomes is spoken of as a measure by which the propensity to consume may be stimulated; but what type of "redistribution" Keynes here has in mind is not clear; at any rate, there is no proof that he meant a modification of incomes according to size (p. 138).

  The decision not to use “improvement” in income distribution to solve lack of aggregate demand could have been, I think, politically motivated. By weighing the political acceptability or political risks of the two solutions, Keynes probably decided to go with greater G as politically and ideologically more acceptable. Neither approach was politically easy, of course. Most of the economics profession and business interests at the time (e.g. US Chamber of Commerce in the late 1930s) were opposed to increased government spending. It involved higher taxes or printing fiat money and surely greater involvement of government in the economy.  But Keynes might have thought that arguing in favor of redistribution could have been even less politically popular among the ruling classes, and for the academic acceptance of his theories even worse, bringing him too close for comfort to Hobson and Sismondi and similar “schools of thought”.

I think there is little doubt that Keynes, under the best and the most favorable interpretation, had no interest in income distribution because he believed that—at least analytically—it can be taken as fixed in its functional and interpersonal aspects. A less charitable interpretation of what he did is to argue  that he was worried that his theories may be conflated with those  of  “underconsumptionists” from the “underworld of economics” (Keynes’ term), who tended to favor change in income distribution as a solution for the lack of effective demand. Keynes did not want to “be” like them and he therefore ignored income distribution throughout.

  

PS. In the very opening chapter of The Economic Consequences of the Peace, Keynes mentions income distribution, but in an unusual way, to argue that high inequality before the World War I was not socially destabilizing so long as the rich were seen not to engage in ostentatious consumption, but to use their excess money for investments—which, of course, create jobs. “…the capitalist classes were allowed to call the best part of the cake theirs and were theoretically free to consume it, on the tacit understanding that they consumed very little of it in practice” (p. 20). They were just simple vessels through which the surplus of purchasing power flowed to get transformed into investments. This was, according to Keynes, a part of the social compact that existed prior to the War and ensured social peace: “I seek only to point out  that the principle of accumulation based on inequality was a vital part of the pre-war order of Society and of progress as we then understood it” (p. 21). He was not sure that it would endure after the War.

 

J. M. Keynes. The general theory of employment, interest and money, Harcourt, Brace and the World, 1964.

J. M. Keynes, The economic consequence of the Peace, Penguin Books, 1971.

Hans Staehle, “Short-Period Variations in the Distribution of Income”, Review of Economics and Statistics,  Vol. 19, No. 3 (Aug., 1937), pp. 133-143

The order of inequality

Professor Tongdong Bai (whom I had the pleasure to meet in Shanghai and who kindly alerted me to his new book) has recently published a book called perhaps somewhat provocatively Against Political Equality: The Confucian Case. The book offers a reinterpretation of Confucian school’s writings. It is a very well-written, tightly argued text equally of interest to those curious to learn more about, or those already tolerably knowledgeable of, the Chinese classics. In this review I focus on two central issues where my opinions may not agree with those of Professor Bai, but there are many other parts of the book, including on contemporary China, that can be studied with great profit by all, and which I do not cover in this review.   

 

The book argues that Confucian writings must not be seen simply as a collection of ethical teachings concerned with virtue and moral improvement but as political philosophy in the strict sense of the term.

 

In order to support his claim, Bai makes the analogy between the political situation faced by Confucius and Mencius (fifth and fourth century BC; relatively close contemporaries of Socrates and Plato), the two authors whose writings provide the bulk of Bai’s textual evidence, and the situation of Western Europe in the 17^th and 18^th centuries, at the time of dissolution of European feudalism. Both were politically pivotal moments. The Chinese, the so-called Zhou-Qin transition, was characterized by the breakdown of hierarchical, nobility-ruled, (loosely speaking) “feudal” order, and incessant warfare. The seven larger states were, as the name of the Warring States period implies (475 BC to 221 BC), engaged in mutual wars and the previous power legitimation was no longer sufficient. Consequently, Bai argues, Confucius’ followers and interpreters, including Mencius, had to reflect on politics, and to find the new bases of legitimation of the political order. This was analogous to the ideological effervescence, to the sudden break-in of “the political”, in the early modern Western Europe.

 

Confucians’ ethical teachings were, in Bai’s view, only secondary to their interest in political philosophy. Merit, virtue, righteousness, sense of duty, play a role, as we shall see, in their political system but it is the redefinition of the political order that they were after, not ethics alone. Perhaps, if one may interpret Bai, ethics were subservient to politics. Confucians were “revolutionary with a conservative façade” (p. 30).

 

The argument  by analogy with Western Europe is used by Bai as an indirect proof that Confucian writings should be considered political philosophy. One of the reason why they often are not is in their style:  aphoristic, allegorical, open to multiple interpretations. Their writings (as, for example, The Analects) are not structurally tight, nor is there an attempt to make all the intermediate points, from an initial statement to its full implication, explicit and clear. Defending this suggestive type of writing, Bai, in a few instances, falls back to the argument that not only are some kinds of knowledge ineffable, but that the authors were so superior in their knowledge to the ordinary person that they did not even see the need to explain their logic in a step-by-step fashion. Nietzsche is conveniently cited saying that the shortest path between the two peaks is the straight one, but only a person with very long legs (meaning superior mind) can make it at one go.  To a rational mind, it is a somewhat strange defense of murkiness in thinking—whereby that very murkiness is exalted to geniality. But it is this style, not fitting the canons of modern Western political philosophy that made, Bai holds unjustifiably, Confucius’ and Mencius’ writings ruled out as political philosophy. This is what needs to be corrected.   

 

Bai’s reinterpretation of Confucius’ and Mencius’ thought (especially of the latter who is cited more than Confucius) is comprehensive and symmetrical. It is comprehensive because it posits the rules for the organization of an ”ideal” state and then moves to the rules for the organization of the international order among these states.

 

The definition of the domestic political order begins with the statement, defended by Mencius more than Confucius, that all persons are in principle equal and capable of moral and cognitive perfection, or at least satisfactory development. That satisfactory development which includes virtuous behavior, regard for the others, empathy, concern with public affairs is developed through a process of education which should be understood much more broadly, as education and upbringing (that is, values that are normally inculcated through familial and friendly socialization). But that particular satisfactory moral development is achieved only by a select group of people. Them, being more “humane” than the others (or, as Bai writes, being truly human while the others may be just barely above the bestial level) are called forth to rule the state. They must rule it so that it is to the material benefit not only of themselves but of everyone including those who are being ruled. In that sense, government is accountable to the public, and its legitimation is based on the quality of its rule, and especially ability to improve economic conditions of the ruled. Bai, probably rightly, emphasizes the parts from Mencius’ teachings that hold that moral virtue cannot be achieved without some material sufficiency: it is difficult to adhere to the fully ethical  rules in deprivation. 

 

The political system thus sketched is, in principle, legitimate (as is based on merit) and accountable to the those who are being ruled. In what Bai calls a Confucian hybrid regime, “masses are competent enough to know whether they are satisfied with the regime and its policies or not, but they are not competent enough to make political decisions that will maintain or lead to a satisfying political environment” (p. 89).  If the system does not live up to what it is supposed to deliver, there is a corrective although it remains unexplained when exactly is the use of the corrective justified (i.e., when a revolution is acceptable) and even more generally how it should be applied (can it be violent or not?).

 

But the problems go much further. Bai, again basing himself on Mencius, argues in favor of what is today called “equality of opportunity”: everybody should have the same chance to succeed. This equality of chances  justifies meritocrats as “rightful rulers.” Leaving aside whether such justification is acceptable (in other words, accepting for the moment that we should be ruled by an “aristocracy” in the etymological sense of the term), two questions, at least, remain.

 

First, are the criteria for distinguishing between those chosen to rule and others acceptable? Will the right to rule be given by the score on SAT exams or good knowledge of ancient poets? How are the norms of “concern with society” as opposed to self-interest and selfishness to be defined and, even more importantly, observed? Who will judge them? Will not the rulers have incentive to bend the system in their favor and claim that whatever  characteristics they possess indicates moral virtue (the way that the chevaliers of the Middle Age saw their pedigrees and ability to handle the sword as most worthy virtues)?

 

The second problem is apparent as soon as the system unfolds  for more than one generation. After agreeing on both the “ideal” nature of such a  state and on the criteria whereby the elite is selected, we can immediately notice that already by the second generation children of the elite will enjoy a much better starting position that the rest of their peers.  So, the initial assumption on which the entire system is premised, namely, an even playing field, collapses as soon as the system begins to develop. It will, as we have seen it amply in history, lead almost inevitably to the rule of a small elite not selected because of any special ability but purely thanks to familial ties, friendship, or patron-client (honestiores-humiliores) relationship.

 

Structurally the same is the theory proposed by Bai---again based on Confucius and Mencius—of international relations. Here, the original distinction made by Confucian thinkers was between the xia or civilized states, and yi or “barbarous” states. Bai is at pains to underscore that this distinction was not made on ethnic criteria, although it was often interpreted as such because, once China got unified, its interactions tended to be with the people whom the Chinese considered culturally inferior even when they were militarily stronger. (This changed only, as Bai writes, with the encounter with the West who was militarily stronger and whom the Chinese could not, given the development of Western philosophy and science, treat as “barbarian”). Confucians proposed differential treatment of xia and yi. The use of violence (say, invasion, change of government, annexation) between the xia states was prohibited. Civilized states may compete, but they should never use violent means against each other. However, a civilized state has the right to use violent means against a barbarous state with the ultimate objective of helping the barbarous state to become xia.

 

Bai applies this rule to today’s international relations holding that internal matters of individual states are not their own affair only but, if they are yi, of international concern. Hence, for example, states that leave their citizens in poverty, violate human rights, try to subvert other states etc. are fair targets for the international community composed of xia states only, and violent behavior toward them is condoned, and perhaps even, desirable.

 

(In a perhaps strange case of historical amnesia, Bai forgets that almost identical arguments, including unremitting poverty, awful sanitary conditions, infectious diseases, and infanticide were used to justify to “civilize” and “pacify” China but that “international effort” to do so brought only wars and destruction. It is unclear why it should be different elsewhere.)

 

It is obvious that such an idea is a prescription for the “greatest disorder under the Heaven”. If the domestic rules for the elite-selection are unclear, as I argued before, how much more unclear and contested will be the international rules that would distinguish between the “civilized” and  “barbarian” states? Let us just mention that the “ideal” state, according to Bai’s own rules, could be regarded by a liberal democratic state as a yi state because it does not accept democracy and the rule by the people. Thus, Bai’s international rules could ironically be used to overthrow his own “ideal” Confucian state! But this is the least of our problems: who is to decide what constitutes a “barbaric state”? Bai’s definition is all-encompassing: “[Barbaric state] is one that either tyrannizes its people out of incompetence or indifference, fails to offer basic services to its people, leaving them in great suffering; moreover, it threatens the well-being of other people or completely disregards its duty to other people such as the duty to protect a shared environment” (p. 185). One can use this definition at will to justify moving a state to the category of “barbarous” or deserving to be overrun by a coalition of “civilized” states.

 

I mentioned that Bai’s domestic and international orders are built symmetrically. The symmetries are in the introduction of a normatively-defined elite (in one case, the educated minority; in the other case, the “civilized” states), in almost breathtakingly broad or easily contestable definitions for such elites, and in the rights given to that elite to rule over the others. In the national case, at least the ruled have, in principle, the right to rebel against the elite if badly run, but in the international case, not even such a notional recourse is envisaged.

 

At both levels, it is thus an extraordinary elitist and unequal order that, so that it might function, has to rely either on exercise of brute power that would keep pacified the domestic “helots” and foreign “barbarians”, or an extremely unlikely acceptance of inferiority by the domestic subjects and the foreign yi. Perhaps this unequal order had some chances to be accepted, tacitly or not, thousands of years ago, but it has (close to) zero chance to be accepted today. Luckily.