Rules and conflict in income distribution: the classical

approach

Antonella Stirati

Università Roma Tre

Natural wage:

• “The doctrine of Adam Smith and other economists is that the normal or “natural” value…is that which economic forces would bring about if the general conditions…were stationary enough to enable them all to work out their full effect” (Marshall, Principles, 1920, p. 289)

• Changes in the data determine “very gradual or secular movements” (ididem, p. 315)

Points in the presentation

• Classification of the interpretations of classical wage theory and “demand for labour”

• Exposition of the “Alternative” interpretation based on the absence of a decreasing demand for labour

• In the light of this interpretation the classical approach is suitable for the investigation of income distribution in contemporary economies

• References: A Stirati: Interpretations of the classics: the theory of wages, Working paper n. 116, and Changes in functional Income Distribution in Italy and Europe, Working paper n. 119, Dipartimento di economia, Università Roma Tre, available on-line

Is it legitimate to speak of a “Classical” approach?

• Common analytical structure

• Intense dialogue and open criticism when disagreement

• Nature of The Wealth of Nations and Ricardo’s Preface

Three interpretations of Ricardian and Classical wage theory

• Fix –wage (Kaldor, Pasinetti)

• New View (Samuelson, Casarosa, Hollander)

• “Alternative” interpretation (Marx, Sraffa, Garegnani, Stirati)

Fix-wage and New View

• Fix wage and New view share the notion of a decreasing relation between wage level and employment, based on the wage fund theory or substitution

w = WF/P , P = population

and agree on

P = f(w-su)

so that the tendency of w to be at subsistence level fundamentally depends on the speed of adjustment of population when w differs from subsistence – If so the theory would not be so different from marginalist theory and would not be of interest for the analysis of modern economies

• The “dynamic relations” alone cannot determine the equilibrium wage.

• Fix wage and new view need a “static” demand function for labour to determine a full employment equilibrium wage in each period

w

p,kkbpakapB

B

E

A

k p

Figura 1: The rates of growth of population and capital as functions of the real wage - point E not a position of rest.

The “Alternative” Interpretation

• Alternative interpretation: central feature of classical approach is the absence of a “static” decreasing relation between wage level and employment.

• This perspectives solves many “puzzles”, such as:

• Ricardo on machinery• Ricardo on taxation of wages and necessaries• Smith’s three contradictory theories

(subsistence, wage fund, monopsony)

Analytical structure 1: the notion of subsistence:• “the quantity of food, necessaries and conveniences

become essential from habit” (Ricardo, Principles p. 93)

• “not only the commodities which are indispensably necessary for the support of life, but whatever the custom of the country renders it indecent for creditable people to be without” (Smith, WN, I.ii.k.3);

• “the rate below which it seems impossible to reduce, for any considerable time, the ordinary wages even of the lowest species of labour” (WN I.viii.14)

Evolution of subsistence minimum over time:

• Ricardo and Smith: subsistence differs in different historical periods

• James Steuart: Political necessaries reflect needs which: “are formed by habit and education and when regularly

established create another kind of necessary [that] has for its object certain articles…which distinguish what we call rank in society” (J. Steuart 1766: 270-71)

• “The workmen, having long enjoied higher incomes will have bettered their way of life, and since they are many, and live uniformly, anithing which obliges them to retrench part of their habitual expence, is supposed to deprive them of necessaries” (J. Steuart, 1766, p. 192-3)

• But how can the subsistence minimum evolve over time?

• This requires the possibility of persistent changes in wages, which in turn lead to the changes in habits and living standards

Analytical structure 2: Forces determining the natural wage

• subsistence

• Institutions barganing position Empl./population

• natural wage

The role of institutions in determining the bargaining position of workers:

• I) separation between work and means of production:

According to Smith, masters’ advantage in bargaing is due to the fact that “ Many workmen could not subsist a week, few could subsist a month…without employment” (WN, I.viii.12)

“The simple workmen, who possesses only his hands…has nothing except in so far as he succeeds in selling his toil to others (Turgot, Reflections, p 122)

Necker attributed the tendency of wages to subsistence minimum to “the terrible inequality between those who sell their labour to meet the subsistence needs of the day…and those who only buy their labour to increase their luxury and comforts..” (Necker, 1975, p.16)

II. Specific Laws and institutions

• According to Smith, masters’ advantage in the dispute over wages

is also due to the fact that:

“the law authorizes… their combinations, while it prohibits those of the

workmen” (WN, I.viii, 11-12);

According to Necker:

“There is no relief …except in the small number of countries where the

form of government leaves some political rights in the hands of the

people…”

“England is the country where the conditions of the people appears to

be the best…the cause must be sought in the form of government,

which gives the people a degree of force…that affects their wages”

(Necker, 1785, p.323; 1775, p. 313)

Bargaining position: the role of labour market conditions• The ratio of the employment level to population affects the relative

bargaining position of workers and masters, and hence the natural wage:

“there are certain circumstances however which sometimes give the laboures an advantage…when the demand for those who live by wages…is continually increasing..the scarcity of hands occasions a competition among masters who bid against one another in order to get workmen…” (WN,I.viii.16-17)

While in a stationary economy:“there would be a constant scarcity of employment, and the labourers

would be obliged to bid against one another in order to get it…the competition of the laboures and the interest of the masters would soon reduce wages to this lowest rate [subsistence] which is consistent whith common humanity (WN, I.viii.24)

Persistent conditions in the labour market affect natural wages:

• “the circumstances which naturally determine the rate of wages are

affected by the advancing, stationary, or declining state of the

society” (WN I. vii. 24)

Implications of the role of labour market conditions and

unemployment:

• i) no tendency to full employment on the demand side;

• ii) population adjustment slow and uncertain: there is a difference

here between natural price and natural wage;

• iii)Demand for labour is a given quantity: number of employed – this

renders Smith internally consistent, against the ‘three theories’ view;

Which notion of competition?

• The coexistence of unemployment and a given wage, that does not tend to fall to zero, conflicts with modern views about the working of competition, but these views are strictly connected with the notion of a decreasing demand curve for labour.

• If a fall in wages does not bring about an increase in employment level, then competition over wages must find a limit or it would become socially destructive

• The classical economists saw competition as a force that would tend to equalize remuneration for labour of equal type – but would affect wage levels only within boundaries – for example, according to Smith, they would not fall below a subsistence level consistent with “common humanity”

For its own structure, the classical approach leads to see a

conflict over income distribution, since the ability of the

workers to obtain higher wages would not be at the cost

of greater unemployment and the income accruing to the

working class as a whole would increase (or vice versa

should wages fall)

• On the other hand, institutions or rules of behaviour

limiting competition over wage levels appear necessary

to ensure social and economic stability: unlimited

competition over wages when there is unemployed

labour would be socially disruptive, since it would not

cure unemployment.

Evolution of income distribution in contemporary economies

• The revival of the classical approach would suggest that changes in income distribution can be interpreted looking at changes in the bargaining position of workers and hence mainly in:

• Labour market conditions

• Institutional setting

The role of labour market conditions and institutional factors in contemporary economies

TABLE 1DEPENDENT VARIABLE:GROWTH RATE OF REAL COMPENSATION°MANUFACTURINGITALY 1962-2006

C Un* Empl°° VA /L.** ST *** 69-71°°° 76-81 93-06over CPI

Eq 1 Coeff 8,1 -0,7 0,6Stat t 7,8 -5,3 3,8

P 0 0 0

Eq 2 Coeff 4,9 -0,44 0,5 0,4Stat t 4,2 -3,5 3,7 4,2

P 0 0,001 0 0

Eq 3 Coeff 4,3 -0,3 0,7 0,3 -0,13Stat t 3,9 -1,9 4,6 2,8 -2,5

P 0 0,065 0 0,007 0,018

Eq 4 Coeff 4,76 -0,27 0,57 0,26 2,32 -2,06 -1,79Stat t 5,99 -2,7 5,48 3,47 3,99 -5,11 -4,24

P 0 0,01 0 0,001 0 0 0

°Real compensation per employee (FTE when available), 3 years moving average of annual growth rate* unemployment, Eurostat definition, 3-years moving average of the level°° employment growth in manufacturing, three years moving average ** manufacturing, 3-years moving average of annual growth rateof value added per person employed (FTE when available)***% of short term contracts over employees, entire economy, 3-years moving average, series starts in 94, assumes value 0 before

-3

-2

-1

0

1

2

3

-2

0

2

4

6

8

10

65 70 75 80 85 90 95 00 05

Residual Actual Fitted

Italy

TABLE 2DEPENDENT VARIABLE:GROWTH RATE OF REAL COMPENSATION° IN MANUFACCTURING

C Un* Empl°° VA/L** 69-71°°° 95°°° Adj R-sq FGE 1962-2006*** over CPI

Eq 1 Coeff 4,85 -0,44 0,4 30Stat t 10,49 -5,51

P 0 0 0

Eq 2 Coeff 2,76 -0,28 0,56 0,7 51Stat t 6 -4,54 6,52

P 0 0 0 0

Eq 3 Coeff 3,9 -0,44 -0,24 0,58 0,74 43Stat t 6,7 -5,49 -2,86 7,29

P 0 0 0,006 0 0

Eq 4 Coeff 3,28 -0,35 -0,13 0,46 3,05 3,5 0,88 65Stat t 8,16 -6,19 -2,03 8,08 5,82 4,24

P 0 0 0,023 0 0 0 0

-2

-1

0

1

2

-2

0

2

4

6

8

10

65 70 75 80 85 90 95 00 05

Residual Actual Fitted

Germany

• In the light of the Alternative interpretation of the classics, focussing on the absence of a decreasing demand for labour, the revival of the classical approach stemming from Sraffa’s contributions can provide an analytical framework to interpret income distribution in contemporary economies by looking at conflict (bargaining strenght of the parties) and rules (institutional regulation of labour market)