Income Distribution Theories

THE DISTRIBUTION OF INCOME has been a central topic of economics since the time of Adam Smith [Page 529]and the classical economists. How income is distributed in a capitalist market economy is a vast, complex, and highly controversial area of economic analysis. In terms of distribution, the focus of classical economics was the so-called functional distribution of income among the three broad factors of production, namely the suppliers of labor, land, and capital.

Wages represented the return to labor, rents the return to land (that is, natural resource ownership), and profits (including interest) the return to capitalists (that is, the owners of various kinds of business enterprise). A key distinguishing characteristic of alternative theories of distribution is whether there is a surplus to be captured by some group and, if so, who will dominate.

David Ricardo developed the leading and most explicit classical theory of distribution in the early 19th century. According to Ricardo, an “iron law” dictated by Thomas Malthus's theory of population governed wage payments. If wages happened to rise above the level required for subsistence by the worker and his family, workers would be induced to rear more children. The increase in population and labor supply in time would drive wages back down to the subsistence level. On the other hand, the return to landowners (land rent) was determined by the cost of production at the margin of cultivation.

Finally, profits were assumed to depend on the wages needed to be paid to sustain the labor force. If wages rose, profits declined. The basic dynamics of Ri-cardo's theory are as follows. Given a growing population, the demand for food will rise. Since lands of less and less productivity must be brought into cultivation to increase food supply, food prices must rise to cover the higher costs of food production. Rising food costs in turn would cause a rise in the subsistence wage.

Thus firms would face rising labor costs and a squeeze on profits. Finally, falling profits would cause a decreased rate of accumulation and investment. In the very long run, a stationary state would result as investment ceased, the limits on food production checked population growth, and all surplus value was captured by landlords in the form of land rents. The very long run presented a dismal picture indeed.