Monday, 2 March 2015

Is technology to blame for economic inequality? 3 ideas in Piketty you need to know to answer this question

Let’s begin with the begging question: Why would technological improvements explain growing economic inequalities in America and elsewhere?

The logic is fairly simple. Technology has a positive impact on the economy as a whole, because it increases productivity, making the production of goods cheaper or more cost effective—workers become more productive and the resources needed to produce goods and services decreases. From this perspective, the issue of income inequality seems foreign and the way it is introduced into the conversation is as follows:

1) By asking about the type of skills needed to be able to use and benefit from technologies—which amounts to asking about the ways in which the presumed gains in productivity come about.

2) By comparing investments in technology with other forms of investment.

How can productivity gains come about if most workers lack the skills to use the available technologies at their disposal?

After raising this question, apologetics of economic inequality hurry to give the following answer: income inequality is the result of having a labor force that is split, between those who possess the right skills and can to take advantage of the technologies available in the 21st century economies and those who lack such skills and find themselves competing for a decreasing number of jobs that don’t require any such skills. In short, this is the story that tells us there is Silicon Valley, on the one hand, with its high-tech innovations and a growing number of millionaires and billionaires. On the other hand, you have the grey old manufacturing sector, which is inefficient and wasteful and that would be symbolized by cities like Detroit in the US or Birmingham or Liverpool in the UK.

Income inequality would, therefore, be a temporary event, whose solution is to motivate people to choose the right professions (ICT related subjects), for, once they do, they will be able to earn the high salaries that those skilled workers at Google have. Is this a feasible story?  What does the evidence tell us?

Thomas Piketty addresses this argument in his Capital in the Twenty-First Century. The evidence, he tells us does not seem to support this theory.

“Over the long run, education and technology are the decisive determinants of wage levels” (Piketty, 2013, pp. 306, 307).

In the short run, however, differences in labour income (in wages) obey directly to three main factors:

1.    Executives have acquired direct influence on their own remuneration and at times even set their own salaries, through direct control over boards of directors—this is a claim supported by Piketty, but also Nobel price winners’ Joseph Stiglitz and Paul Krugman.
2.    Pay for luck: positive changes in a firm’s external conditions (economic growth, prices of raw materials, exchange rates, competitors’ performance) are rewarded as if generated internally—by the leadership and strategic mind-set of upper echelon employees (Piketty, 2013, p. 335).
3.    Decreases of top marginal income tax rates in English speaking countries since the 1980s, was followed by an explosion of very high incomes, which accelerated the growth rate of economic inequality during the last 30 years (Piketty, 2013, p. 335).
4.    The main source of income of the richest 1% is not their wage, that is, income inequality is NOT primarily explained by disparities in wages (Piketty, 2013, p. 280).

Next to these factors, I said too that in comparing investments in technology with other forms of investment, such as investment in real estate property, the former are presumed to accrue higher rewards, because they entail equally high risks. This means, for instance, that someone like Steve Jobs, who made what was back in the early eighties a very risky investment in an incredible innovation (the personal computer) received an equally high reward, when his innovation proved its merit and became very profitable. In comparison, if you or I, who are fearful of risk, prefer, in turn, a safer investment (a savings account for example), it is only logical that we cannot expect high rewards. Under this light, innovations are taken as the philosopher stone of wealth creation, and to a certain extent long run economic growth does depend on innovation (Piketty, 2013, p. 306).

Yet, is it feasible to put the blame of economic inequality on smart investments (high risk, high reward) against lame investments (low risk, low reward)?

Piketty’s answer is that the historical evidence does not suggest this to be the case, even remotely, for a single, yet quite important reason: the rate of return of portfolios increases not as their investment on innovations increases, but rather as the amount of capital invested increases—on average the largest endowments are able to obtain real returns of close to 10 percent a year, while smaller endowments must make do with 5 percent returns (Piketty, 2013, p. 449).

Technology has, no doubt, been fundamental to the economies of the 19th, 20th and 21st centuries and has, to be sure, been disruptive of the ways we used to do things in the past—and it will probably play the same role in the future. The issue of economic inequality, however, cannot be blamed on technological advancement.

Written by Daniel Vargas Gómez

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