Chapter 4: The Distribution of Income

FOR MORE THAN A CENTURY SOCIALIST WRITERS HAVE LEVELED TWO main charges against capitalism: (1) It is not productive (or only wastefully productive, or far less productive than some imaginable socialist system would be); (2) It leads to a flagrantly unjust "distribution" of the wealth that it does produce; the workers are systematically exploited; "the rich get richer and the poor get poorer."

Let us consider these charges. That the capitalist system could ever have been accused of being unproductive, or of being very inefficiently productive, will seem incredible to most economic students of the present day, familiar with the record of the last generation; it will seem even more incredible to those familiar with the record since the middle of the eighteenth century. Yet the improvement in that early period remained hidden even from some astute contemporary observers. We have already seen how little the Malthus of 1798 (the date of the first edition of his Essay on Population) was aware of the productive transformation already achieved in the first half of the Industrial Revolution.

Yet much earlier, in 1776, Adam Smith had shown keen awareness of improvement: "The uniform, constant, and uninterrupted effort of every man to better his condition... is frequently powerful enough to maintain the natural progress of things toward improvement, in spite of the extravagance of government, and of the greatest errors of administration." ⁽¹⁾

Smith rightly attributed this progress to the steady increase of capital brought about by private saving -- to the "addition and improvement to those machines and instruments which facilitate and abridge labor."

"To form a right judgment" of this progress, he continued, "one must compare the state of the country at periods some what distant from one another [so as not to be deceived by short periods of recession]. ... The annual produce of the land and labor of England, for example, is certainly much greater than it was a little more than a century ago at the restoration of Charles II." And this again was certainly much greater "than we can suppose it to have been about a hundred years before, at the accession of Elizabeth." ⁽²⁾Quite early in The Wealth of Nations we find Smith referring to the conditions of his own period as being comparatively, as a result of the increasing division of labor, a period of "universal opulence which ex tends itself to the lowest ranks of the people."⁽³⁾

If we leap ahead another century or more, we find the economist Alfred Marshall writing in the 1890s:

"The hope that poverty and ignorance may gradually be extinguished derives indeed much support from the steady progress of the working classes during the nineteenth century. The steam engine has relieved them of much exhausting and degrading toil; wages have risen; education has been improved and become more general. ... A great part of the artisans have ceased to belong to the 'lower classes' in the sense in which the term was originally used; and some of them lead a more refined and noble life than did the majority of the upper classes even a century ago." ⁽⁴⁾

For more recent years we have the great advantage of getting beyond more or less impressionistic comparisons of economic progress to fairly reliable statistical comparisons. Our chief care here must be to avoid making such comparisons in terms of dollar income at current prices. Because of the continuous monetary inflation in the United States since the 1930s, this would give a very misleading impression. To get a true picture of the real improvement in production and welfare, in so far as these are measurable, allowance must be made for price increases. Statisticians do this by deflating recent prices and incomes in accordance with index numbers of average prices -- in other words, by making their comparisons in terms of so-called "constant" dollars.

Let us begin with some overall figures. In the 59 years between 1910 and 1969 it is estimated that the real gross national product of the United States (the GNP) increased at an average rate of 3.1 percent a year compounded. ⁽⁵⁾ At such a rate the production of the country has been more than doubling every 24 years.

Let us see how this has looked expressed in billions of 1958 dollars:

In the ten years from 1939 to 1949, then, the real gross national product of the country increased 55 percent; in the twenty years from 1939 to 1959 it increased 127 percent; in the thirty years from 1939 to 1969 it increased 242 per cent.

If we now express this in terms of disposable per capita personal income (at 1958 prices) for these same years, the comparison is less striking because we are allowing for the growth in population, but the progress is still remarkable:

In other words, disposable per capita personal income at constant prices increased 112 percent -- more than doubled -- in the generation from 1939 to 1969.

This disposes effectively of the charge that capitalism is unproductive, or unacceptably slow in increasing production. In the thirty years from 1939 to 1969 the United States was still the most capitalistic country in the world; and the world had never before witnessed anything comparable with this vast production of the necessities and amenities of life.

Gains Shared by the Masses

The foregoing figures do nothing, it is true, to answer the charge that capitalism distributes its gains unjustly -- that it benefits only the already rich, and leaves the poor, at best, no better off than they were before. These charges are at least partly answered, however, as soon as we compare the median incomes of families in constant (1969) prices:

As the median income means that there were just as many families earning more than the amount cited as those earning less, it follows that the 97 percent increase of median real incomes in this twenty-year period must have been shared in by the mass of the people. (The median incomes of "unrelated individuals," calculated on the same 1969 price basis, rose from $1,641 in 1949 to $2,931 in 1969.)

Other sets of figures confirm this conclusion. If we simply compare actual weekly wages paid in manufacturing, we find that these rose from $23.64 in 1939 to $129.51 in 1969 -- an increase of 448 percent. As the cost of living was constantly rising during this period, this of course greatly exaggerates labor's gains. Yet even after we restate these wages in terms of constant (1967) prices, we find the following changes in average gross weekly earnings:

So far from wages failing to keep pace with increases in living costs, real wages rose 108 percent in this thirty-year period.

Was the worker getting his "fair share," however, in the general increase in production -- or was he getting a smaller share compared with, say, the owners of industry?

Let us begin by looking at the sources of personal income. Of the nation's total personal income of $801 billion in 1970, $570.5 billion, or 71 percent, was in wages and salaries and other labor income. Income from farming came to $16.2 billion, or 2 percent; business and professional income was $51.4 billion, or 6.4 percent. Rental income received by persons was $22.7 billion, or 2.8 percent; dividends came to $25.2 billion, or 3.1 percent; interest received by persons was $65.2 billion, or 8.1 percent. (Source: Economic Indicators, June, 1971, Council of Economic Advisers.) If we total these last three items we get $113.1 billion, or 14.1 percent, of "unearned" income. (The income from farming and from business was partly "earned" and partly "unearned," in undeterminable proportions.)

It is doubtful how much all this tells us about the distribution of income between the "rich" and the "poor." Total wage and salary disbursements include the salaries of highly paid executives and of television and motion-picture stars. On the other hand, rentals, dividends, and interest payments include many millions of moderate-sized individual sums that may represent the major part or the sole means of support of widows and orphans and persons too old or too ill to work. (There are some 30 million American stockholders, for example, and 25 million savings-bank accounts.)

A very significant figure, however, is the comparison of how much the employees get from the corporations with how much the owners get. Let us look first at a few facts about profits. In the five-year period from 1966 to 1970 inclusive, all manufacturing corporations of the United States earned profits after Federal income taxes of only 4.9 cents per dollar of sales. Manufacturing corporation profits after taxes as a percentage of stockholders' equity look a little better -- they averaged 11.6 per cent for the same five years. (Source: Economic Report of the President, January, 1972, p.282.)

Both of these figures, however, overstate the real profits of the corporations. In a period of continuous inflation like the pre sent, the corporations are forced by the tax laws to make inadequate deductions for depreciation of plant and equipment,

based on original cost, and not sufficient to cover replacement costs. Profits as a percentage of equity are overstated for still another reason: they are stated in dollars of depreciated purchasing power compared with the dollars that were originally invested.

Lion's Share to Employees

What is more significant (and constantly forgotten) is that the employees of the corporations draw far more from them than the owners. This is exactly the opposite of what is commonly believed. Surveys by the Opinion Research Corporation have found that the median opinion of those polled was that the employees of American corporations receive only 25 cents out of each dollar available for division between the employees and the owners, and that the remaining 75 cents go to profits. The facts are quite the opposite. In 1970, for example, of the U.S. corporation income available for distribution between the workers and the owners, nine tenths went to the workers and only one tenth to the owners. Here is how, in billions of dollars, the division appeared over a series of years:

If we average out the five years from 1966 to 1970, we find that compensation to employees came to 88.2 percent of the corporation income available for division, and only 11.8 percent, or less than an eighth, to profits available for shareowners.

Suppose we look not at what was theoretically available for the shareholders but at what they were actually paid in those years in dividends. In the five years from 1966 to 1970 dividends averaged just about half of corporate profits after taxes. Com pared with total payments to employees of $1,603.0 billions in the period, total dividends came to $115.2 billions. In other words, the corporation employees received almost fourteen times as much in pay as the shareowners received in dividends.

So if American workers are being "exploited" by the capitalists, it is certainly not evident on the face of the figures. One important fact that the anticapitalist mentality so often forgets is that corporation earnings do not constitute a common pool. If manufacturing corporations earn an average of 12 percent on their equity, it does not mean that every corporation earns this average profit margin. Some.will earn 20 percent on equity, some 10 percent, some 3 percent -- and many will suffer losses. (Over a 40-year period an average of 45 percent of companies -- by number-reported losses annually. As a general rule, small companies suffered losses more frequently than did the large corporations.)

Another point to be kept in mind: When profits are large, it does not mean that they are at the expense of the workers. The opposite is more likely to be true. In 1932 and 1933, for example, the two years when the nation's corporations as a whole showed a net loss, the workers also suffered their worst years from unemployment and wage cuts. In a competitive capitalistic economy, aggregate profits and aggregate wages tend to go up and down together, with a slight lag for wages. And, of course, when profits fall, unemployment rises. The following table compares corporate profits before taxes with compensation of employees (both in billions of dollars), and with percent age of unemployment in ten selected years.

It is in the long-run interest of the workers as well as stockholders for profits to be high. Ironically, union leaders are al ways complaining about "excessive" profits, and forgetting that wages and employment are directly dependent on the out look for profits.

Turning from the sources of income, we come now to increases in family incomes over recent years and to the division of income between various segments of the population. Because of rising prices, comparisons between different years of family incomes in current dollars have little meaning. Here is a comparison, however, of the percent distribution of white families by income level, in constant (1968) dollars, between 1950 and 1968:

The sharp drop in the percentage of families with "constant" incomes under $3,000 is especially noteworthy. The rise in the overall "real" median income in this eighteen-year period was 79 percent.

A Look at Family Incomes

The percent of aggregate income received by each fifth of the number of families in the country and the percent of aggregate income received by the top 5 percent of families have changed much less over the years, but such change as has occurred has been toward a more equal distribution:

If the reader wishes to know how the various fifths of the population ranged in actual incomes in 1970, and in which fifth or bracket his own family income fell, he can learn it from the following table:

The income comparisons presented in this chapter fail to give any support whatever to the socialist contention that under a capitalist system the tendency is for the rich to get richer and for the poor to get poorer -- or at any rate for the proportional "gap" between the rich and poor to increase. What the figures show, on the contrary, is that in a healthy, expanding capitalist economy the tendency is for both the rich and the poor to get richer more or less proportionately. If anything, the position of the poor tends to improve better than proportionately.

This becomes even clearer if, instead of merely comparing incomes in terms of dollars, we look at the comparative gains of the poor that have been brought about by the technological progress that has in turn to so large an extent been brought about by capitalism and capital accumulation. As Herman P. Miller has pointed out:

"Looking back, there is good reason to wonder why the 1920s were ever regarded as a golden age. ... Take for example a simple matter like electric power. Today electricity in the home is taken for granted as a more or less inalienable right of every American. Practically every home -- on the farm as well as in the city -- is electrified. Even on southern farms, ninety-eight out of every hundred homes have electricity. In 1930, nine out of every ten farm homes were without this 'necessity.' And the country was much more rural than it is now.

"A more striking example is provided by the presence of a toilet in the home. ... As recently as 1940, about 10 percent of city homes and 90 percent of farms lacked toilet facilities within the structure. This is not Russia or China that is being described, but these United States only thirty years ago. "⁽⁶⁾

Even the skeptical Paul Samuelson conceded in 1961 that "the American income pyramid is becoming less unequal." ⁽⁷⁾

Amenities for the Masses

There can be little doubt that the technological progress of the last two generations has meant more to the families at the bottom of this pyramid than to those at the top. It is the overwhelming majority of Americans that now enjoy the advantages of running water, central heating, telephones, automobiles, refrigerators, washing machines, phonographs, radios, television sets -- amenities that millionaires and kings did not enjoy a few generations ago.

Here are some of the figures of the percentage of American households owning cars and appliances in 1969:

In view of the fact that government statisticians officially placed the "poverty threshold" for 1969 at $3,721 for a family of four, and $4,386 for a family of five, the percentage of families with incomes less than this owning cars and appliances is remarkable. In 1969, in addition, 90 percent of all American households had telephone service.

To these figures on the distribution of physical appliances we must add many intangibles. The most important of these is the enormous increase in the number of those who have enjoyed the advantage of an education. Broadly speaking, the percent age increase has been greatest for those at the bottom of the pyramid. A century ago (1870), only 57 percent of all children between 5 and 17 years of age attended school. By the turn of the century this had risen to 76 percent, by 1920 to 82 percent, and by 1960 to 89 percent. It was as low as this in 1960 only because children were starting school at 6 years of age instead of at 5. Nearly 97 percent of all children between 7 and 17 years of age were in school in 1960. Even more dramatic are the figures on schooling at a higher level. In 1870, only 2 percent of the relevant age group graduated from high school. This tripled to 6 percent by 1900, tripled again to 17 percent by 1920, and again to 50 percent by 1940. It had reached 62 percent by 1956. Enrollment in institutions of higher education -- junior colleges, colleges, and universities -- was less than 2 percent of the relevant age group in 1870, and more than 30 percent in 1960. ⁽⁸⁾

Presenting the contrast in another way: Since 1910 the proportion of high school and college graduates has approximately doubled every thirty years. The percentage of adults who were high school graduates increased from 13.5 in 1910 to 24.1 in 1940 and to 54.0 in 1969. Comparable figures for college graduates in the same years were 2.7, 4.6, and 10.7 percent respectively. The proportion of adults with less than five years of school decreased at about the same rate that the graduates rose. The decline was from 23.8 percent in 1910 to 13.5 in 1940 and to 5.6 in 1969. ⁽⁹⁾

We have seen that under a capitalist economy the tendency is for both rich and poor to become better off more or less proportionately, but that this economic progress has nevertheless meant more to those at the bottom of the income pyramid than to those at the top. These two results are not inconsistent. In a market economy, as overall productivity and real per capita incomes both increase, the production of each individual good or service is not increased proportionately, but that of the goods most urgently wanted by most people is increased most. This reflects the changes brought about by increased real income in individual marginal utilities. Even apart from the specific direction of technological progress, when everybody's real income doubles, say, the marginal satisfactions of those at the bottom of the income scale are increased more than the marginal satisfactions of those at the top. The latter merely buy more luxuries, or save more; the former can afford more necessities. Hence even a merely proportional increase in unequal incomes tends to reduce inequalities in real welfare. Or to put it another way, the proportional inequalities tend to mean less.

Pareto's Law

In 1896 the Italian economist Vilfredo Pareto, after a study of different countries for which statistics were then available, and also as between various periods of time, found that the statistics of inequality in the distribution of wealth showed a remarkable correspondence. As a result he framed what be came celebrated as the Pareto Curve, or Pareto's Law. What he found was that the highest incomes were received by very few people, but from the highest to the lowest brackets of incomes there was a steady progression in the number of people who received them, and if the numbers in these different brackets were plotted they followed a remarkable and almost uniform curve. If the various levels of income and the number of per sons in receipt of each level of income are represented graphically by logarithms, the "curve" so drawn is a straight line.

For the nonmathematical, Pareto also represented the distribution of wealth by a bell-shaped figure with concave sides, very broad at the base, for the large number receiving the lowest incomes, and very narrow at the top, for the small number receiving the highest incomes. This "law" has been defended by many eminent statisticians and economists and attacked by many others. Carl Snyder declared, "the Pareto Curve is destined to take its place as one of the great generalizations of human knowledge." ⁽¹⁰⁾ A. C. Pigou was among those who criticized it.

Both defenders and critics have too often been influenced by emotional bias, and have tended to accept or reject the "law" in accordance with their political preconceptions. Social reformers have attacked it both because of its implication that incomes vary directly with the abilities of different individuals, and in proportion to those abilities. Pigou contended that there was no reason to suppose Pareto's law to represent a necessary distribution of income, and that to the extent that the "law" might be statistically valid it was so because "income depends, not on capacity alone, whether manual or mental, but on a combination of capacity and inherited property. Inherited property is not distributed in proportion to capacity, but is concentrated upon a small number of persons." ⁽¹¹⁾

Serving the Masses

Whatever the truth about Pareto's Law may be or may have been, the long-run historical tendency of capitalism has not only been to increase real incomes more or less proportionately nearly all along the line, but to benefit the masses even more than the rich. Before the Industrial Revolution the prevailing trades catered almost exclusively to the wants of the well-to-do. But mass production could succeed only by catering to the needs of the masses. And this could be done only by success in dramatically reducing the costs and prices of goods to bring them within the buying power of the masses. So modern capitalism benefited the masses in a double way -- both by greatly increasing the wages of the masses of workers and greatly reducing the real prices they had to pay for what was produced. Under the feudal system, and nearly everywhere before the Industrial Revolution, a man's economic position was largely determined by the economic position of his parents. To what extent is this true in the United States of the present day? This is a difficult question to answer in quantitative terms, because one of the intangibles a man tends to "inherit" from his parents is his educational level, which so largely influences his adult earning power. But some of the partial answers we do have to this question are surprising. Herman P. Miller tells us:

"In 1968 fewer than one family out of a hundred in the top income group lived entirely on unearned income -- interest, dividends, rents, royalties, and the like. The other ninety-nine did paid work or were self-employed in a business or profession. Nearly all of these families were headed by a man who worked at a full-time job. In 1968 over four-fifths of these men worked full time throughout the year. ⁽¹²⁾

They also seemed to work longer hours than the average worker. Among the rich, also, "relatively few admit to having inherited a substantial proportion of their assets. Even among the very rich -- those with assets of $500,000 or more -- only one-third reported that they had inherited a substantial proportion of their assets; 39 percent claimed to have made it entirely on their own, and an additional 24 percent admitted to having inherited a small proportion of their assets. ⁽¹³⁾ /p>

International Comparisons

I have said nothing so far of the comparison of American incomes with those of other nations. In absolute figures -- in gross national product per capita, in ownership of passenger cars and TV sets, in use of telephones, in working time required to buy a meal -- these comparisons have been all heavily in favor of the United States. In 1968, the per capita gross national product of the country came to $4,379, compared with $3,315 in Sweden, $2,997 in Canada, $2,537 in France, $1,861 in the United Kingdom, $1,418 in Italy, $1,404 in Japan, $566 in Mexico, and $80 in India.' ⁽¹⁴⁾

More immediately relevant to the subject of this chapter is a comparison of the distribution of income in the United States with that in other countries. In this respect also the result has been largely in favor of the United States. A comparison of conditions in the 1950s made by Simon Kuznets found that the top 5 percent of families received 20 percent of the U.S. national income. Industrialized countries like Sweden, Denmark, and Great Britain showed approximately the same percentage. It was in the "underdeveloped" countries where the greatest internal disparities existed in incomes. For example, in El Salvador the top 5 percent of families received 36 percent of the national income, in Mexico 37 percent, in Colombia 42 percent. This comparison is one more evidence that capitalism and industrialization tend to reduce inequalities of income.

A Misleading Phrase

I have entitled this chapter "The Distribution of Income," and have been using that phrase throughout; but I have done so with reluctance. The phrase is misleading. It implies to many people that income is first produced, and then "distributed" -- according to some arbitrary and probably unjust arrangement.

Something like this idea appears to have been in the back of the minds of the older economists who first began to arrange their textbooks under these headings. Thus Book I of John Stuart Mill's Principles of Political Economy (1848) is entitled "Production," and Book II, "Distribution." Mill wrote, at the beginning of this second book:

"The principles which have been set forth in the first part of this Treatise are, in certain respects, strongly distinguished from those on the consideration of which we are now about to enter. The laws and conditions of the production of wealth partake of the character of physical truths. There is nothing optional or arbitrary in them..

"It is not so with the Distribution of Wealth. That is a matter of human institution solely. The things once there, mankind, individually or collectively, can do with them as they like. ... The distribution of wealth, therefore, depends on the laws and customs of society."

This distinction, if not altogether false, is greatly overstated. Production in a great society could not take place -- on the farms, in the extraction of raw materials, in the many stages of processing into finished goods, in transportation, marketing, saving, capital accumulation, guidance by price and cost and supply and demand -- without the existence of security, law and order, and recognized property rights -- the same rules and laws that enable each to keep the fruits of his labor or enterprise. Goods come on the market as the property of those who produced them. They are not first produced and then distributed, as they would be in some imagined socialist society. The "things" are not "once there." The period of production is never completed, to be followed by some separate period of distribution. At any given moment production is in all stages. In the automobile industry, for example, some material is being mined, some exists in the form of raw materials, some in finished or semifinished parts; some cars are going through the assembly line, some are on the factory lots awaiting shipment, some are in transport, some are in dealers' hands, some are being driven off by the ultimate buyers; most are in use, in various stages of depreciation and wear and need of replacement.

In brief, production, distribution, and consumption all go on continuously and concurrently. What is produced, and how much of it, and by what method, and by whom, depends at all times on the relative sums that those engaged in the process are receiving or expect to receive in profits or wages or other compensation. Production depends no less than distribution on "the laws and customs of society." If farmer Smith raises 100 bushels of potatoes and farmer Jones 200 bushels, and both sell them for the same price per bushel, Jones does not have twice as much income as Smith because it has been "distributed" to him. Each has got the market value of what he produced.

It would be better to speak of the variation between individual incomes than of their "distribution." I have used the latter term only because it is customary and therefore more readily understood. But it can be, to repeat, seriously misleading. It tends to lead to be prevalent idea that the solution to the problem of poverty consists in finding how to expropriate part of the income of those who have earned "more than they need" in order to "distribute" it to those who have not earned enough. The real solution to the problem of poverty, on the contrary, consists in finding how to increase the employment and earning power of the poor.

Notes

1. Adam Smith, The Wealth of Nations, Book II, Ch. III.

2. Loc. cit

3. Ibid., Book I, Ch. I.

4. Alfred Marshall, Principles of Economics, 8th Ed., New York, Macmillan, pp.3-4.

5. Based on estimates by the Department of Commerce expressed in "constant" (1958) dollars.

6. Herman P. Miller, Rich Man, Poor Man, New York, Thomas Y. Crowell Co., 1971, pp. 44-45.

7. Paul Samuelson, Economics: An introductory Analysis, 5th ed., New York, McGraw Hill Book Co., p.114.

8. Author's source: Rose D. Friedman, Poverty: Definition and Perspective, Washington, American Enterprise Institute, 1965, p.11.

9. Digest of Educational Statistics; 1970 ed. Office of Education, U.S. Department of Health, Education, and Welfare, p.10.

10. Carl Snyder, Capitalism the Creator, New York, The Macmillan Co., 1940, p.417

11. A. C. Pigou, The Economics of Welfare, London, Macmillan, 4thed., 1946, p.651.

12. Miller, op. cit, p.150.

13. Ibid., p.157.

14. Statistical Abstract of the United States 1970, p.810.

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