Monthly Archives: May 2016

Wealth and Income Inequality in the Early Modern Period

Comparing Income and Wealth Inequality in Pre-Industrial Economies: Lessons from 18th-Century Spain

By Esteban A. Nicolini (Universidad Carlos III de Madrid) and Fernando Ramos Palencia (Universidad Pablo de Olavide)

Abstract: In this new working paper on preindustrial inequality, Nicolini and Ramos Palencia build upon their earlier work on income inequality in eighteenth-century Old Castile (Nicolini and Ramos Palencia 2015) by looking into one particularly important, and difficult to assess, aspect: how to reconstruct, for a given preindustrial society, estimates of both income and wealth inequality – considering that the sources, according to the place and the period, have the tendency to inform us only about one of the two. Given the amount of new information about long-term trends in preindustrial inequality, of either income or wealth, which has been made available by recent research, the authors point at what clearly constitutes one of the next steps we should take and in doing so, they also provide a useful contribution to the methodological debates which are taking place among scholars working on preindustrial inequality.

URL: http://econpapers.repec.org/paper/heswpaper/0095.htm

Distributed by NEP-HIS on 2016-03-29

Review by Guido Alfani

Summary

In this paper Nicolini and Ramos explore the connection between income and wealth for a large sample of communities from different Spanish provinces: Palencia, Madrid, Guadalajara and Granada. They combine information from two different sources:

1. the Catastro de Ensenada (ca. 1750), which provides information about household income, and

2. probate inventories (covering the period 1753-68), a source which has often been used to estimate wealth inequality.

These two sources are combined using nominative linkage techniques in order to take advantages of one to solve the weaknesses of the other. In particular, the almost-universal scope of the survey within the Cadastre enables Nicolini and Ramos to assess with certain precision the actual coverage of the probate inventories (which tend to be biased towards the upper part of the distribution). This allows them the resampling or weighthing of the information to improve the study of wealth inequality. It should be underlined that the Catastro de Ensenada is a truly exceptional source. It was an early attempt at introducing a universal tax on income. As the new tax was proportional and should have replaced a number of indirect provincial taxes with regressive effects, this fiscal innovation clearly moved in the direction of a more equitable system of taxation. Unfortunately, the new tax was never implemented – but at the very least, the attempt to introduce it generated a vast amount of useful information.

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Nicolini and Ramos were able to reconstruct both income and wealth for 194 observations, out of the much larger sample of 6,214 households for which they only have information about income. Nicolini and Ramos then explore the connection between income and wealth, finding (as was expected) a very strong correlation. However, they go much deeper, thanks to an econometric approach in which the distortions in the sample (determined in particular by over-representation of rich households) are corrected by weighting. They obtain many interesting and potentially useful results, in particular:

  1. they estimate the average rate of return to wealth to be 2.9% p.a. – which is, generally speaking, much smaller that usually implied in the literature. For instance, the rate of return to wealth implied by Lindert in his work on the Florentine Cadastre of 1427 was 7% p.a. (see below). However, if the association between income and wealth is analyzed by considering their logarithm (which is the econometric specification preferred by Nicolini and Ramos), then the elasticity of income to wealth varies between 0.4 and 0.9 depending on the region. This means that a 10% increase in household wealth is associated to an income increase comprised in the 4-9% range. This range is consistent with empirical findings in many studies of past and present societies, all of which suggest that income inequality is lower than wealth inequality;
  2. the distribution of household income increases less steeply than the distribution of household wealth. This might be due to the fact that labour income is relatively larger in the bottom part of the distribution, or that the wealth of the bottom part of the distribution consists for a larger part of income-producing assets, while the wealth of the richest people would consist also of other assets, including (unproductive) status goods and luxuries as well as cash;
  3. the relationship between wealth and income differs depending on the sector of activity of the household head (primary vs secondary/tertiary) and on the place of residence – although somewhat surprisingly, and differently from what reported for other European regions (for example Tuscany by Alfani and Ammannati 2014), Nicolini and Ramos do not find that urban households had greater wealth than rural ones. In the study by Nicolini and Ramos urban and rural wealth were usually on par, but in the extreme case of Guadalajara urban dwellers were less wealthy than rural dwellers.

 

Sample of Catastro de Ensenada (Archivo Simancas)

Sample of Catastro de Ensenada (Archivo Simancas)

 

Comment

This paper makes many interesting and potentially important contributions to the study of inequality in the early modern period, a field which has been particularly fertile in recent years. First, it provides new information about inequality in the Iberian peninsula, integrating other recent studies (e.g. Santiago-Caballero 2011; Reis and Martins 2012). Secondly, it contributes considerably to the development of a methodology to translate in a non-arbitrary way income distributions into wealth distributions, and vice versa. This is a crucial point, which deserves some attention.

The Ensenada Cadastre is an exceptional source as it provides data on income. As a matter of fact, most other sources of the “cadastrial” kind are essentially property tax records, which always list real estate and sometimes other components of wealth – but not income. However, it has also been argued that for the preindustrial period, in most instances wealth distributions are the best proxy we have for income distributions (Lindert 2014; Alfani 2015). This being said, moving from the good-quality distributions of wealth that have recently been made available for different parts of late medieval and early modern Europe (in particular, Alfani 2015; Alfani and Ryckbosch 2015) to acceptable distributions of income is clearly a worthy pursuit.

I would differ with Nicolini and Ramos Palencia in their statement that theirs is the first attempt at studying together income and wealth distributions in the pre-industrial period. For example, Soltow and Van Zanden (1998) did so in their study of the Netherlands. However, Nicolini and Ramos do provide useful and interesting insights into how to convert wealth distributions into income distributions. Many such attempts are currently underway and there are earlier examples, like Lindert’s method to convert the distribution of wealth in the 1427 Florentine catasto into an income distribution (results used in Milanovic, Lindert and Williamson 2011).

Moreover, Nicolini and Ramos Palencia stress many potential pitfalls in procedures of this kind. This being said, there are aspects of their current reconstructions which are a bit surprising and might be the result of sampling issues, as 59% of the 194 observations relate to the province of Palencia. Is Guadalajara, where rural dwellers were wealthier than urban dwellers, an exceptional case or does this depend on the very small sample (just 12 observations) the authors have for that region? To dispel any doubts, more probate inventories should be collected, in order to improve the territorial balance within the sample and to better account, both in the estimation process and in the econometric analysis, for possible regional variations. However, this does not alter the general conclusion. The paper by Nicolini and Ramos is a very useful piece of innovative research, grounded in new archival data and packed with useful insights about how to improve our knowledge of inequality in the pre-industrial period.

 

Ferdinand VI (1713 – 1759), called the Learned, was King of Spain from 9 July 1746 until his death.

Ferdinand VI (1713 – 1759), called the Learned, was King of Spain from 9 July 1746 until his death.

 

Selected Bibliography

Alfani, G. (2015), “Economic inequality in northwestern Italy: A long-term view (fourteenth to eighteenth centuries)”, Journal of Economic History, 75 (4), 2015, pp. 1058-1096.

Alfani, G. and Ammannati, F. (2014), Economic inequality and poverty in the very long run: The case of the Florentine State (late thirteenth-early nineteenth centuries), Dondena Working Paper No. 70.

Alfani, G., Ryckbosch, W. (2015), Was there a ‘Little Convergence’ in inequality? Italy and the Low Countries compared, ca. 1500-1800, IGIER Working Paper No. 557.

Lindert, P.H. (2014), Making the most of Capital in the 21st Century, NBER Working Paper No. 20232.

Milanovic, B., Lindert, P.H. and Williamson, J.G. (2011). “Pre-Industrial Inequality”, The Economic Journal 121: 255-272.

Nicolini, E.A. and F. Ramos Palencia (2015), “Decomposing income inequality in a backward pre-industrial economy: Old Castile (Spain) in the middle of the eighteenth century”, The Economic History Review, online-first version, DOI: 10.1111/ehr.12122.

Reis, J., Martins, A. (2012), “Inequality in Early Modern Europe: The “Strange” Case of Portugal, 1550-1770”. Paper given at the conference Wellbeing and Inequality in the Long Run (Madrid, 1 June 2012).

Santiago-Caballero, C. (2011), “Income inequality in central Spain, 1690-1800”, Explorations in Economic History 48(1): 83-96.

Soltow, L. and Van Zanden, J.L. (1998), Income and Wealth Inequality in the Netherlands, 16th-20th Century. Amsterdam, Het Spinhuis.

Lessons from ‘Too Big to Fail’ in the 1980s

Can a bank run be stopped? Government guarantees and the run on Continental Illinois

Mark A Carlson (Bank for International Settlements) and Jonathan Rose (Board of Governors of the Federal Reserve)

Abstract: This paper analyzes the run on Continental Illinois in 1984. We find that the run slowed but did not stop following an extraordinary government intervention, which included the guarantee of all liabilities of the bank and a commitment to provide ongoing liquidity support. Continental’s outflows were driven by a broad set of US and foreign financial institutions. These were large, sophisticated creditors with holdings far in excess of the insurance limit. During the initial run, creditors with relatively liquid balance sheets nevertheless withdrew more than other creditors, likely reflecting low tolerance to hold illiquid assets. In addition, smaller and more distant creditors were more likely to withdraw. In the second and more drawn out phase of the run, institutions with relative large exposures to Continental were more likely to withdraw, reflecting a general unwillingness to have an outsized exposure to a troubled institution even in the absence of credit risk. Finally, we show that the concentration of holdings of Continental’s liabilities was a key dynamic in the run and was importantly linked to Continental’s systemic importance.

URL: http://EconPapers.repec.org/RePEc:bis:biswps:554

Distributed on NEP-HIS 2016-4-16

Review by Anthony Gandy (ifs University College)

I have to thank Bernardo Batiz-Lazo for spotting this paper and circulating it through NEP-HIS, my interest in this is less research focused than teaching focused. Having the honour of teaching bankers about banking, sometimes I am asked questions which I find difficult to answer. One such question has been ‘why are inter-bank flows seen as less volatile, than consumer deposits?’ In this very accessible paper, Carlson and Rose answers this question by analysing the reality of a bank run, looking at the raw data from the treasury department of a bank which did indeed suffer a bank run: Continental Illinois – which became the biggest banking failure in US history when it flopped in 1984.

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For the business historian, the paper may lack a little character as it rather skimps over the cause of Continental’s demise, though this has been covered by many others, including the Federal Deposit Insurance Corporation (1997). The paper briefly explains the problems Continental faced in building a large portfolio of assets in both the oil and gas sector and developing nations in Latin America. A key factor in the failure of Continental in 1984, was the 1982 failure of the small bank Penn Square Bank of Oklahoma. Cushing, Oklahoma is the, quite literally, hub (and one time bottleneck) of the US oil and gas sector. The the massive storage facility in that location became the settlement point for the pricing of West Texas Intermediate (WTI), also known as Texas light sweet, oil. Penn Square focused on the oil sector and sold assets to Continental, according the FDIC (1997) to the tune of $1bn. Confidence in Continental was further eroded by the default of Mexico in 1982 thus undermining the perceived quality of its emerging market assets.

Depositors queuing outside the insolvent Penn Square Bank (1982)

Depositors queuing outside the insolvent Penn Square Bank (1982)

In 1984 the failure of Penn would translate into the failure of the 7th largest bank in the US, Continental Illinois. This was a great illustration of contagion, but contagion which was contained by the central authorities and, earlier, a panel of supporting banks. Many popular articles on Continental do an excellent job of explaining why its assets deteriorated and then vaguely discuss the concept of contagion. The real value of the paper by Carlson and Rose comes from their analysis of the liability side of the balance sheet (sections 3 to 6 in the paper). Carlson and Rose take great care in detailing the make up of those liabilities and the behaviour of different groups of liability holders. For instance, initially during the crisis 16 banks announced a advancing $4.5bn in short term credit. But as the crisis went forward the regulators (Federal Deposit Insurance Corporation, the Federal Reserve and the Office of the Comptroller of the Currency) were required to step in to provide a wide ranging guarantee. This was essential as the bank had few small depositors who, in turn, could rely on the then $100,000 depositor guarantee scheme.

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It would be very easy to pause and take in the implications of table 1 in the paper. It shows that on the 31st March 1984, Continental had a most remarkable liability structure. With $10.0bn of domestic deposits, it funded most of its books through $18.5bn of foreign deposits, together with smaller amounts of other wholesale funding. However, the research conducted by Carlson and Rose showed that the intolerance of international lenders, did become a factor but it was only one of a number of effects. In section 6 of the paper they look at the impact of funding concentration. The largest ten depositors funded Continental to the tune of $3.4bn and the largest 25 to $6bn dollars, or 16% of deposits. Half of these were foreign banks and the rest split between domestic banks, money market funds and foreign governments.

Initially, `run off’, from the largest creditors was an important challenge. But this was related to liquidity preference. Those institutions which needed to retain a highly liquid position were quick to move their deposits out of Continental. One could only speculate that these withdrawals would probably have been made by money market funds. Only later, in a more protracted run off, which took place even after interventions, does the size of the exposure and distance play a disproportionate role. What is clear is the unwillingness of distant banks to retain exposure to a failing institution. After the initial banking sector intervention and then the US central authority intervention, foreign deposits rapidly decline.

It’s a detailed study, one which can be used to illustrate to students both issues of liquidity preference and the rationale for the structures of the new prudential liquidity ratios, especially the Net Stable Funding Ratio. It can also be used to illustrate the problems of concentration risk – but I would enliven the discussion with the addition of the more colourful experience of Penn Square Bank- a banks famed for drinking beer out of cowboy boots!

References

Federal Deposit Insurance Corporation, 1997. Chapter 7 `Continental Illinois and `Too Big to Fail’ In: History of the Eighties, Lessons for the Future, Volume 1. Available on line at: https://www.fdic.gov/bank/historical/history/vol1.html

More general reads on Continental and Penn Square:

Huber, R. L. (1992). How Continental Bank outsourced its” crown jewels. Harvard Business Review, 71(1), 121-129.

Aharony, J., & Swary, I. (1996). Additional evidence on the information-based contagion effects of bank failures. Journal of Banking & Finance, 20(1), 57-69.

Schumpeter 3

Neo-Schumpeterian views of Economic Development Today

The Theory of Economic Development of J.A. Schumpeter: Key Features

By Iurii Bazhal (Economics Department, National University of Kyiv-Mohyla Academy)

Abstract: This paper comprises translation into English of the preface of Iurii Bazhal to the first Ukrainian edition of Joseph Schumpeter’s famous fundamental book “The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle” that was translated in Ukrainian and published in 2011 in commemoration of its 100th anniversary. The paper reveals the contemporary significance of this classical book as the challenger on replacing the neoclassical approaches in capacity to become the mainstream of modern economic theory. It is shown that Schumpeter’s approach gives a new vision of driving forces for economic development where a crucial conceptual place belongs to the category of innovation. Second part of the paper reviews modern Neo-Schumpeterian approaches which have substantiated the importance of the structural innovation technological change of national economy for economic development. The government must permanently analyze a compliance of the actual production structure in the country with the current and future technological paradigms.

URL: http://EconPapers.repec.org/RePEc:pra:mprapa:69883

Distributed by NEP-HIS on: 2016-03-29

Reviewed by Stefano Tijerina (University of Maine)

In an effort to recommend economic policy solutions to the “young market economy” of Ukraine, Iurii Bazhal breaks down Joseph Schumpeter’s principles of national economic development, arguing that current global implementations of economic development policies dominated by the neoclassical economic model are not generating and have never generated “evolutionary innovative ‘jumps.’”(p. 12). Emerging economies and stagnant advanced economies would benefit immensely from the revision of the neoclassical approach, centering instead on the Neo-Schumpeterian approach that recognizes economic structures of technological systems as the base of long-term economic growth (idem). From Bazhal’s perspective, business-government partnerships should focus on national economic development strategies that center on the creation and advancement of innovative technological systems that generate revolutionary global social, cultural, economic, and political change.

Schumpeter 3

These historical transformations that have changed humanity and its relation to resources and the natural world have catapulted some nations into positions of power that have translated into national economic prosperity. Bazhal identified five “paradigms” that altered the economic development of the modern world, including the substitution of machinery for handwork in weaving (1790-1850), coal mining and the steam engine (1851-1895), iron industry (1896-1946), oil based energy and organic chemistry products (1947-1989), and microelectronics (1990-2040). Schumpeter identified these periods as “dynamic” periods of economic development (pp. 4 & 13).

Contrary to “static” development where reproduction of traditional production structures were replicated nation after nation across the world, “dynamic” economic development based on technological innovation was and continues to be the only solution for capitalist nations interested in substantially increasing their national wealth and social welfare (p. 4). Nations spearheading the different periods of global innovation promoted and justified the implementation of the revised status quo in order to legitimize its global systemic outreach, restraining other nation’s ability to create and produce new dynamic value added solutions to their own development strategy (idem). This, said Bazhal, explained the “trap” that has impeded the present economic development of nations such as Ukraine (idem).

Ukraine 1

In order to achieve “dynamic” economic development like the one that catapulted Britain and the United States into positions of global power, it was necessary to move beyond the “model of circular flow of income and expenditure between firms and households” promoted by the neoclassical macroeconomic model (p. 6). This Schumpeterian view that “new combinations” of economic development strategies and technologies is what takes nation states into new realms of economic development patterns is what Bazhal is arguing for Ukraine. Combinations, I would argue, that are exemplified in Brazil’s reinvention into an ethanol-based economy that moved the nation away from oil dependency and thus breaking the restrains imposed by the oil based development model advanced by the United States throughout the Twentieth Century. Brazil’s case represented a “disruption of equilibrium by new combinations,” as Schumpeter would put it (p. 7). A new equilibrium based on an increase in the size of resources, the size of capital, the size of the labor force and the size of the national domestic product represent at that point Schumpeterian dynamics of economic development. Impactful and effective economic development therefore lies in business-government relations where the innovative entrepreneur has the flexibility and authority to influence the direction of policy; norms, regulations, and institutional designs that allow the entrepreneurial forces to implement and carry forward new “combinations or innovations”(idem).

A more deregulated system, argues Bazhal, would allow Ukraine’s entrepreneurial forces to move forward with the model recommended by Schumpeter. Yet the neoclassical restrains promoted by the European Union, the United States and the multilateral agents impede the clicking of new combinations (p.8). Ukraine’s economic development salvation lies in the invention or creation of a “new technological paradigm” that will catapult the nation into a more advanced economic development stage within the global economic market system (p. 11). This evolutionary dynamic, argues Bazhal, must be accompanied by “structural technological changes” that will guarantee stable economic development conditions at the design and implementation stages of the policy.

Schumpeter’s theory indicates that for this to take place, the nation’s business and political actors must also be willing and prepared to execute the “creative destruction” of the traditional systems and philosophical ideas of production. This aspect of the evolutionary process, from my perspective, is what is impeding Brazil from capitalizing fully from its transformation into an ethanol-based economy. Although not highlighted by Bazhal, the economic, political, social, cultural, domestic and international struggle against the forces of status quo are factors that require a more thorough analysis. In the case of Ukraine it is these same forces that block the nation’s self-determined transition into an evolutionary technological economic development dynamic.

Schumpeter 1

The implementation of a Neo-Schumpeterian economic development model in Ukraine or in any other nation across the world would look similar, in relative terms, to what happened in the United States during the oil or the microelectronics era. The new technological wave became the core driver of the nation’s economy, impacting at first the internal dynamics and systems of production and then replicating the same outcome nation after nation in incremental patterns. Not all nations converted to fossil fuels at once but eventually all did, accompanied by the construction of roads for the transit of vehicles together with the adoption of multiple other technologies and innovations that justified the conversion into a fossil fuels-based world. The same pattern has been developing on front of our eyes as the world adjusts to the microelectronics era.

As in the case of Brazil, a new technological innovation emanating from Ukraine would result in new structures of enterprise, new dynamics and interrelations between multiple economic indicators and sectors, new secondary and service productions sectors, in addition to value added systems, new forms and sectors for investment, new capital flows, new consumption patterns, and new domestic and international patters of trade flows.

Theoretically Bazhal’s advancement of the New-Schumpeterian model as the adequate paradigm shift for the Ukrainian economy is convincing and proven to be effective, as I pointed out in the case of Brazil, but the challenge remains in the implementation stage. Although Bazhal is aware that the technological revolution results in drastic changes on the state’s economic system and that it threatens the interests of those currently benefitting from the production status quo, he never provides his or Schumpeter’s solutions to these challenges. The success stories of Britain and the United States in altering the technological status quo indicate that domestically engineered social and political control systems must become an integral part of the sophisticated nation building process of post-modern nation states in order to secure flexibility for Schumpeter’s entrepreneur and the effective and efficient maneuverability of the government-business partnerships that advance the Neo-Schumpeterian model domestically and internationally.