Startup general interest

Are economists to blame for growing wealth inequality?

By July 2, 2014 2 Comments

A couple of weeks ago I wrote about the dangers of growing wealth inequality and suggested that governments take action to promote social mobility and increase back to work training budgets. The unstated assumption behind that post is that growing inequality is an inevitable byproduct of modern capitalism and politics is the only source of redress.

This article from Stephen Denning argues that rising wealth inequality is the byproduct of 20th century economics, citing Milton Friedman’s 1970 theory that the responsibility of firms is to maximise profits and Meckling and Jensen’s 1976 paper Theory of the Firm which argues for incentivising senior managers with stock options as two examples.

Like many others I grew up viewing these theories as self-evident truths. My thinking was that companies are owned by their shareholders and should therefore organise themselves to deliver what those shareholders want – typically profits. At one level I still have a hard time shaking that idea – shares in a company are owned like money, or property, or cars, and it seems only right that they do what their owner would like them to do.

The problem, however, is that this widely held view is delivering bad results for society. The short term dynamics of stock markets are as much to blame as the economic theories, but Denning’s article raises the alluring prospect that new economic theories might give us a path out of our current predicament. More likely, new economic theories might provide the intellectual underpinning for politicians to take action. At the moment many politicians feel helpless in the face of market forces (largely because capital is highly mobile).

Those of you that think that politicians are never any help and that political theory is a waste of time might be interested in the following quote from Keynes that Denning dug out:

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.

Looking back it’s fair to say that I was a slave of Friedman and Meckling and Jensen. In many ways I still am.