Inflation, Income Distribution and X-Efficiency Theory

A Study Prepared for the International Labour Office...

Harvey Leibenstein

• Verlag: Routledge
• Jahr: 2022
• ISBN:
  9781000648744
• Auflage: 1
• Thema: Business
• Thema: Business General

First published in 1980, Inflation, Income Distribution and X-Efficiency Theory presents an exploratory theoretical study of the linkages between income distribution, the degree of X-efficiency, and inflation and the level of employment in the context of developing society. It discusses themes like concept of income distribution; maximization versus non-maximization models; theory of inert areas; microtheory and inflation; monopoly and X-Efficiency theory; contracts, bargaining and inflation; theory of bargaining; survival strategies in the face of inflation; and policy implications of inflation. This book is a must read for students and scholars of macroeconomics and economics in general.

1	INTRODUCTION

In the course of doing this study I was surprised to discover that there existed virtually no systematic work on the consequences of inflation on the development of less developed countries — and especially on the impact of inflation on income distribution. What is meant by systematic is specified in later chapters, but one does not have to interpret this term too narrowly to learn that it is difficult to find anything even in relatively well-stocked economics libraries. Also, the relation of bargaining power to the impact of inflation on income distribution is rarely, if ever, treated in studies of income distribution in less developed countries. I hope that readers of this book will be convinced, as I am, that connecting bargaining power to income distribution is a natural way of looking at the problem.

Inflation has to be studied from a special viewpoint, one that differs from that of conventional microeconomic theory, if we are to see the role that bargaining power plays in determining the impact of inflation on income distribution and development. These basic ideas represent the viewpoint that is expounded in Chapters 3 and 4 under the rubric of X-efficiency theory. These ideas are too complex to be captured in a paragraph or two, but are quite straightforward when considered in the course of a chapter or two. For readers who are economists one bit of special mental effort may be required. We have to forget the postulate of maximising behaviour, or be ready to relax that assumption at various points in our discussion.

In the last three decades the economic experiences of most developing countries have been accompanied by various degrees of inflation. Surprisingly, inflation has not been a central subject of study within the economic development literature. Nor for that matter, has it been a central issue in the examination of the determinants and consequences of income distribution. There are probably a number of institutional reasons for the way economists choose subjects for study which may help explain why this should be the case. One additional aspect comes to mind: existing economic theory does not readily lend itself to connecting inflation and those phenomena having to do with employment, productivity, innovation and capital accumulation, which are central elements in the study of economic development.

For the most part inflation has been viewed by economists as a macroeconomic phenomenon. According to this view, inflation is something which is caused by, and should be understood in terms of, governmental economic activities. On the one hand, inflation is most frequently seen as a consequence of central bank policies and its influence on the aggregate supply of money, the interest rate and the supply credit. Equally important is the view of inflation as a consequence of government taxation and expenditure policies. Since, in the course of development, governments frequently face considerable pressure to increase expenditures beyond their actual tax receipts, or even beyond their taxing powers, governments yield to deficit finance policies. There can be little doubt that the handling of the monetary and budgetary aspects of government are extremely significant elements in our understanding of the inflation process. Nevertheless, it is only part of the overall picture.

It is myopic to see inflation only as a macro phenomenon and to miss or understate micro elements. This is similar to viewing price determination by looking only at the supply side without examining the demand side; and, in part, it is similar to looking at aggregates without examining in any way the individual decisions and acts which are the components of the summarised statements which express aggregate behaviour.

For a moment let us look at inflation from a simple viewpoint; namely, as an increase in the average prices of goods and services. It is incorrect to believe that governments are the only ones that determine the price level. Prices are set by firms, and by those who engage in producing goods and services and trading in them. Thus, the way in which prices are set is either part of the market mechanism, or part of the administrative mechanisms used by private or public firms. These mechanisms and bargaining procedures cannot be ignored if we are to understand the inflationary process. This brings us to the analysis of the relation between price setting and the forces that determine prices in specific individual markets. Two aspects come to mind on the nature of these forces: (i) those elements that determine the nature of the bargains made within markets, and (ii) the changing costs of production and distribution. The latter involves the productivity of labour when labour is viewed in the broadest possible sense. The former involves the nature of markets which we will discuss later in terms of the concept of relative bargaining power.

Why should we care about either bargaining power or productivity in the analysis of inflation? We will argue that both help to determine two significant aspects of inflation: the generation of inflationary pressure which increases the demand for money, and the impact of inflation on income distribution.

It may be argued that the impact of inflation on income distribution is a short-run phenomenon — that somehow it all evens out in the long run and that income distribution is determined by ‘real’ factors, such as relative input productivity, and the distribution of ownership of inputs. Even if this were the case, it is nevertheless important to examine whether we should care about short-run influences on income distribution. We will show that this is especially significant with respect to welfare criteria that we shall introduce as a way of assessing the importance of different income distributions. Most important, this welfare criterion, the ‘vulnerability criterion’, is especially significant in the case of developing countries.

Inflationary processes distort various prices and related elements in the economy, and distort the normal incentives which influence economic behaviour. This is especially likely to be important in the case of developing countries, since such effects of inflation on production, and on the specific nature of capital accumulated, are likely to determine the degree of employment creation. To the extent that developing countries are characterised by various degrees of open and disguised urban employment, we will want to study the extent to which such aspects are influenced by the same considerations which influence the building up of inflationary pressures, and its detailed impact on the distribution of income.

In the course of carrying out the study, it became apparent to the author that a good deal of the statistical basis for the study of such problems simply does not exist. In part this may be that statistics have not been collected for other purposes. For example, international trade statistics are frequently collected as a consequence of the administration of a system of tariffs and import licences. But, with respect to the issues we are considering, especially the relationship between inflation and production, there is little reason for us to collect such statistics as a by-product of other administrative duties. In addition, the sort of questions we raise in this study simply have not been asked, or not asked forcefully enough, so that there has been no intelligent reason, or policy purposes for collecting statistics of the type desired. In general, then, there have been both theoretical and practical reasons why the kind of questions we will want to consider can not be handled at the present on a solid empirical basis. Nevertheless, part of the objective of this study is to argue that these questions are significant.

This book should be viewed as an exploratory theoretical study. It is essentially a speculative essay on a number of issues that are usually not connected to each other, but which we plan to link in various ways, in the hope that the material will suggest that such linkages are useful. Our major aim is to see if reasonable links can be established between such aspects of an economy as its income distribution, the degree of X-efficiency, inflation and the level of employment in the context of a developing society, and to see if any interesting implications result. Not all possible linkages will be attempted, and special efforts will be made not to attempt to forge links artificially.

The basic linkages to be emphasised are the following: (i) to show that there are connections between X-efficiency theory and the process of inflation, apart from the inflation dampening influences of governmental monetary and budgetary policies; (ii) to some extent, we hope to examine the impact of inflation on some characteristics or components of income distribution; (iii) also, an attempt will be made to relate the inflation process to the determination of the level of employment. Thus, the basic links will be between X-efficiency theory, inflation and employment creation; (iv) finally, the policy implications of these various linkages will be taken up in the last chapter.

2	ON INCOME DISTRIBUTION

I. Income Distribution — Some General Remarks

Both as a field of research, and as an area of practical concern, work in income distribution is exceedingly diffuse. There is an unusually large number of specific topics that comes under this heading. While this is hardly the place to review the entire field,¹ it may be useful to make some general remarks to separate those aspects we will consider, or touch on, from those which we will ignore.

One curious characteristic of the field is that most of the statistical literature appears to be almost completely unrelated to the theoretical work done in this area. For example, most statistical work has to do with the size distribution of incomes. In particular, a number of inequality coefficients have been developed and computed, such as the Gini coefficient, whose intent is to indicate the degree of inequality of a specific income distribution, or to compare degrees of inequalities of different income distributions.² Yet, as has been argued by Chenery,³ as well as others, we have no theory for size distribution of income. On the other hand, most of the theoretical work that does exist deals with the functional theory of income distribution. On a macro level, it involves the theory of specific wage rates earned by individuals with specific skills. The neoclassical marginal productivity theory of labour is the major example of this type. Both a theory of functional shares between those that provide labour and those that provide capital, and the specific wage theory, depends on the notion of the production function. In fact, all of these theories are connected in some way via the theory of production, and loosely connected to the theory of size distribution, but the connection is incomplete.

Consider for a moment the theory of wages and its possible connection to the size distribution of income. Clearly, the wages received by individuals are related to income distribution, but they are only a part of the factors that determine income distribution. At the very least, we would also need a theory of asset ownership and its distribution, in order to explain income distribution. But we do not have a theory of the distribution of asset ownership.⁴ This is entirely apart from the question as to whether or not any particular theory of wages happens to be correct. While some of the considerations concerning the theory of wages, and its applicability to income distribution problems, apply to all economics, there is one set of considerations that is especially applicable to the less developed countries. Even if we had a theory of wages that was an adequate theory for income distribution explanations, it would only apply to wage-receiving labour. But one of the characteristics of less developed countries is that a very high proportion of those generally designated as the poor are self-employed. Most frequently they are self-employed in what has been termed the informal market. The magnitude of those who are self-employed is frequently over fifty per cent, among the poorest portion of the people. Hence, even if wage theory did apply to those who are employees, it would be unhelpful in examining the income received by the self-employed and, hence, would be unhelpful in understanding the most vulnerable portion within the income distribution.⁵ The two other elements which are exceedingly important are the family, through the inheritance system, which in part influences the distribution of assets, and the family’s role in determining education, which in turn influences the distribution of skills.⁶ It seems quite obvious that in many instances, family position is one of the main factors in determining an individual’s position in the income distribution. Hence, demographic variables turn out, in various ways, to be exceedingly important as forces that determine income distribution.

An interesting speculation on these matters, which connects some of the factors we have discussed to problems of economic development, is presented in the study by Adelman and Morris. They write:

Our analysis provides some grounds for speculating about the mechanisms that operate before the takeoff point to depress the standard of living of the poorest 40 per cent. In the very earliest stage of dualistic growth, increased wage payments to indigenous workers in modern plantation, extractive, and industrial enterprises tend to be more than offset by concurrent changes in population, relative prices tastes, and product availability. The lowering of death rates through the introduction of modern health measures such as malaria control accelerates population growth and thus tends to depress the per capita income of the indigenous population. Since cash wages are not immediately matched by increased availability of consumer’s goods, higher prices erode gains in money income. Subsistence farmers shifting to cash crops are particularly hard hit by rising prices. Typically they suffer both declines in real income and nutritional deficiencies as they become dependent on the market for major necessities previously produced at home.⁷

The view presented by Adelman and Morris is of special interest, since it is based on a great deal of cross-sectional statistical work involving 74 countries and employing 48 qualitative measures of social, economic, and political variables.

Adelman’s and Morris’s concern with the lowest 40 per cent in the income distribution, brings up another aspect of the literature. A great many writers are really concerned with the sources of poverty, or relative poverty, rather than with income distribution as such. There is a special concern with more impoverished segments of society and attempts to explain how their condition fluctuates in the course of economic development. This concern should be kept in mind in the next section, in connection with our discussion of the concept of ‘vulnerability’.

The causation of relative poverty may run for various circumstances to poverty, but a more heroic hypothesis that is sometimes invoked, is that there is a clear-cut relationship between economic development and relative poverty. On the whole, a number of authorities agree that, in general, the income distribution worsens in the early stages of development, but that it improves as development proceeds.⁸ Whether this is factually true, or whether it is an artefact of the extreme data problems involved in measuring real income in the agricultural sector, is difficult to determine. It should be mentioned in passing that most relatively careful studies indicate considerable concern about the quality of income distribution data, but, despite this concern, the writers usually proceed in the attempt to measure degrees of inequality to the best of their ability.

In this book we shall simultaneously be concerned with the income distribution problem in terms of the functional distribution of income, as well as those aspects that deal with the relatively impoverished members of society. The reason for this dual concern is not because we feel there is a clear-cut relationship between the functional distribution and the lower deciles of the size distribution, but because the main analytical ideas which we shall employ happen to have considerable bearing on the production function, and theories which explain the functional distribution on that basis, as well as a bearing on some aspects of the size distribution of income.

To the extent possible, we will attempt to avoid judgements on the problem of income distribution as such. The main reason for this is not that it is necessarily desirable to avoid such judgements, but simply that to do so would involve a variety of philosophical issues that would detract from the type of considerations that are the main point of this book.

II. Comments on the Concept of Income Distribution

Income inequality is a complex and subtle idea which looks as though it is a simple one. The main reason it is frequently considered simple is because it often seems easy for people to make comparisons. Thus it is easy for some individual to argue that another individual is much richer ...

Inhaltsverzeichnis

• Cover
• Half Title
• Title Page
• Copyright Page
• Original Title Page
• Original copyright Page
• Table of Contents
• 1. Introduction
• 2. On Income Distribution
• 3. X-Efficiency Theory
• 4. The Importance of X-Efficiency Theory for Inflation
• 5. The Impact of Inflation on Developing Countries
• 6. Incomplete Contracts, Bargaining and Inflation
• 7. Bargaining
• 8. Multiple Position Bargaining Analysis
• 9. Review and Policy Implications
• Index