Economic Theory And The Distribution Of Income

Mark Thoma does a nice job in this article in describing the problems that economists have in determining whether income distribution is fair. Marx, and early economists, including Smith and Ricardo, had a labor theory of value. In fact, Marx's theory of class conflict was based upon his understanding of Smith and Ricardo. Keynes was aware of this, and that is one of the reasons why he found fault in Ricardo and other proponents of classical economics.

The labor theory of value takes the position that consumption goods and capital goods require labor in their production. Those who extract value from the sale of goods and services through the ownership of capital are necessarily in conflict with labor that produces the value. That, of course, leads to a conflict between labor and the owners of capital.

An alternative description a value is based upon another theory of value determination. In this theory, the value of a good or a service is determined by the price that one is willing to pay for the utility received from a purchase. Therefore, the value of a good or service cannot be determined by the quantity of labor required for its production. Value becomes more subjective. Owners of capital, landlords, managers and labor all make a contribution to the value or utility of goods and services. The subjective assumption is then made that all receive a share of the value that is equal to their contribution to the output of goods and services. The result is assumed to be fair, and the basis for class conflict disappears.

The problem with this more harmonious theory of value is that it is based upon the assumption of perfect competition. If this assumption does not hold, and there are few perfectly competitive markets, it is more difficult to argue that income is distributed in accordance with ones contribution to output. Profits, which go to the ownership class, will be greater under conditions of monopolistic competition or monopoly. This sets up the conditions that support a progressive tax system that redistributes income from those who benefit from imperfect markets to those who do not.

This analysis leads us to some of the issues that we are debating today. For example, increases in productivity used to be shared between labor and capital more equally. In recent years, the benefits from productivity growth have been less equally shared. Moreover, the tax system has been made less progressive as well. That is how we have gotten into the conflict is described as the battle between the top 1% and the 99%. We are back to the difficult problem of determining fairness.