Wilkinson and Pickett have provided ample evidence in The Spirit Level[i] that excessive income inequality is harmful to the welfare of society. But, as they are not economists, they have not given much evidence about the rationale for income inequality. Understanding the causes of income inequality – and of excessive income inequality – is essential background to any serious attempt to alleviate this defect in the British economy . As Wilkinson and Pickett have shown, other economies which are more successful than Britain’s – such as those of Scandinavia and Japan – are much more equal than Britain’s. Distribution of income varies markedly between countries. Sweden and Japan have similar low levels of inequality of post tax income, but achieve this in different ways. Japan starts off with low inequality in relation to pre tax income, while incomes are more unequal in Sweden but marginal rates of direct tax are high.
The following analysis is based mainly on the work of Guy Routh, late of The University of Sussex. In my opinion, Guy was one of the greatest economists of the twentieth century, but his work has been ignored by the majority of economists because it runs counter to their preconceptions.
A widely held view is that “If you are paid a lot it must be because you are worth a lot.” And yet large classes of people are paid the same, whether they are lazy or industrious, saint or rogues, geniuses or idiots. This applies to masses of politicians, teachers, doctors nurses, shop assistants, coal miners, bus conductors, bricklayers.”[ii]
.The most widely accepted theory is that the price of different sorts of labour, like that of different sorts of goods, is determined by the interaction of demand and supply: pay tends to gravitate to the level at which the demand for a particular skill is equal to the supply. A variation of this theory allows for firms to manipulate the supply of skills within their organisation by training and promotion within their own “internal labour markets.” Employers need only be concerned with external labour markets at certain ports of entry. Within the firm, job evaluation and the pay which is appropriate for any individual’s position in the organisation can be sustained, and only occasionally disturbed by shocks from the outside world. There is practically no outside restraint which can prevent a firm paying someone well over their “market rate”. [iii] However, if a firm becomes short of skills which are only available at rates higher than prevail inside the firm (for example, if a firm needs a particular type of software engineering skill in short supply) then it may have to disturb its internal pay scales by paying a particular group of people more than is justified by their position in its hierarchy.
Pay structures tend to retain remarkable stability over long periods. Substantial changes in employment in various industries and occupations occur without substantial changes in pay relativities. For example, an OECD study found that ‘Industries have in general been able to expand their employment as necessary by increasing recruitment of new entrants, the unemployed and employed job seekers.’[iv]
Routh adduces extensive evidence to refute the conventional theory in which supply and demand are the dominant factors affecting relative pay levels. [v] Between 1906 and 1960, differentials between the average pay of unskilled manual workers in Britain narrowed and widened over time with no apparent relationship between the demand and supply for these two broad groups of labour. In this period, there were two occupations, tool-setters and setter-operators and shorthand typists where there was consistent and exceptionally high excess demand. In relation to tool-setters and setter-operators, rather than moving supply and demand into closer equilibrium, the pay of these groups hardly moved over time relative to other engineering workers and the shortages increased A similar situation of consistent excess demand applied to shorthand-typists.
Similarly, between 1972 and 1977, the average pay of women rose relative to men. Conventional economic theory would indicate that this should have led to a decline in the numbers of women employed relative to men But the reverse happened: employment of women increased while employment of men decreased.
Free competition could be expected to lead to a situation in which the net benefits offered by all jobs would tend to equality. In other words, badly paid jobs would offer good conditions to compensate for low pay, and it would be necessary to offer high pay to compensate for jobs which had to be carried out in poor conditions. In fact, however, it is obvious that in the real world, the reverse applies: the best paid jobs usually offer the best conditions, and jobs which are carried out in poor conditions are also generally the worst paid. As John Stuart Mill observed
“The really exhausting and the really repulsive labours, instead of being better paid than others, are almost invariably paid the worst of all, because performed by those who have no choice … The more revolting the occupation, the more certain it is to receive the minimum of remuneration, because it devolves on the most helpless and degraded, on those who from squalid poverty, or from want of skill and education are rejected from all other employments.”[vi]
According to Cairnes [vii] each individual can only choose his employment ‘within certain tolerably defined limits’ “What we find, in effect, is not a whole population, but a series of industrial layers, superimposed on one another, within each of which the various candidates for employment possess a real and effective power of selection ….the average workman, from whatever rank he be taken, finds his power of competition limited for practical purposes to a certain range of occupations, so that , however high the rate of remuneration in those which lie beyond them may rise, he is excluded from sharing them”
Marshall confirms the weakness of unskilled labourers’ position in the labour market, because their wages do not allow them to save very much and, if they stop work, there are usually large numbers of others able to replace them. They have little bargaining power in relation to their employers. In contrast, the professional classes “have larger reserve funds, more knowledge and resolution, and much greater power of concerted action with regard to the terms on which they sell their services.”[viii]
In relation to Britain, Routh concludes that there is “an occupational distribution and occupational pay structure supported by class stratification, not completely rigid, and yet set enough to limit severely competition for higher-paid jobs”.
The British post second world war experience indicates that it is possible to secure suffiicient people with the skills required for any occupation which offers above average pay and condtions by subsidising the education and training necessary to enter the occupation.
After the Second World War, public education prepared a larger proportion of the population for higher paid occupations. Between 1935 and 1955, higher professional pay fell from 395 to 269 per cent of the all-class average and lower professional pay from 188 per cent to 114 per cent. during the same period, there was a substantial increase in the numbers of full time university students receiving public grants. During this period, teachers suffered a substantial reduction in their relative pay. Yet it proved possible first to make up for the wartime fall in the number of teachers and then increase their numbers by more than 20 per cent between 1949 and 1956. By 1955, there were more qualified applicants than places at colleges for training teachers. In effect, potential entrants to the teaching profession were paid from the date that their specialised training began, and they or their parents were relieved from the expense of paying fees and maintenance, and of supporting them during their training. [ix] Sir John Cassels mentioned the shortage of sewing machinists caused by their low pay.[x] The work is, in fact, quite skilled. The low pay in sewing resulted to a considerable extent from it being an occupation in which low status people -generally working class women – were employed. In Britain, skilled occupations in manufacturing suffered from skill shortages principally because better paid service occupations became available to many of those whose forefathers found that their best chance of a steady job was by becoming apprenticed to a skilled trade.
Conventional neoclassical economic theory claims that the pay that people receive is mainly related to their productivity – people are paid what they are worth. The theory has been disproved many times by the collection and deployment of empirical evidence – such as that compiled by Guy Routh.. Yet this theory remains dominant in discourse amongst the population in general and amongst politicians. The most blatant example is the recent case of the bankers who nearly succeeded in disrupting the capitalist world’s financial system. It is widely believed that these same bankers are still worth the enormous pay and bonuses they award themselves. Governments whose members are reasonably sane – if often inept – are scared to limit or tax heavily the pay and bonuses which senior bankers pay themselves for fear that these bankers would emigrate and deprive their countries of the very valuable services which they provide. Few people seem to recognise that the principal reason why senior bankers are paid huge salaries and bonuses is because they are greedy people who control enormous funds. Their high pay and bonuses have little relationship to their contribution to productivity or to anything else. These greedy people simply allocate large proportions of the funds they control to themselves. Why do some other controllers of large, profitable enterprises, pay themselves much less than senior bankers? The answer is breathtakingly simple. The senior executives of major multinational corporations are often quite greedy people, but generally nowhere near as greedy as senior bankers. British bankers’ advocates claim that should their salaries and bonuses be reduced substantially, many of them would emigrate to better paid jobs abroad. That is almost certainly nonsense. Well paid bankers in the United States, Japan, Europe and elsewhere are no doubt heavily engaged in paying themselves quite high salaries and bonuses. Why would they want to invite unemployed British bankers to join in their feasts?
Wage and salary structures change at times and remain stable for long periods mainly as a consequence of social forces and other forces related to the strengths and weaknesses of the various interest groups in a society. If, for political, social or economic reasons, governments decide to restrain the pay of highly paid occupations, or to tax them heavily, it is extremely unlikely that there will be serious adverse effects on the economy.
[i] Richard Wilkinson and Kate Pickett., The Spirit Level:Why more equal societies almost always do better, London, Allen Lane, 2009
[ii]Guy Routh. The Morals of Pay, in Guy Routh, Dorothy Wedderburn, Barbara Wootton: The Roots of Pay Inequalities.,Low Pay Unit, London, October 1980, p11.
[iii]Peter B. Doeringer and Michael J. Piore, Internal Labor Markets and Manpower Analysis, Heath Lexington Books, 1971.
[iv]Wages and Labour Mobility, OECD, Paris1965
[v]Guy Routh.,Occupation and Pay in Great Britain, 1906-1979, London, Macmillan, 1980, pages 181 -220
[vi] John Stuart Mill, Principles of Political Economy
[vii]J.E. Cairnes, Some Leading Principles of Political Economy Newly Expounded, London ,Macmillan, 1874, pages 64 to 78.
[viii]A. Marshall, Principles of Economics, London, Macmillan ,1920. page 568.
[ix]Routh, op cit p194
[x] Sir John Cassels, Britain’s Real Skill Shortage and what to do about it. Lon don, Policy Studies Institute, 1991 p3