Six reasons why income inequality is good

3

December 14, 2011 by galudwig

Michael Wilson from northamericaneconomics.com had some interesting things to say about yesterday’s post. While I agree with some of his observations, it also made me reflect on our differences in opinion, which, as I see it, spring from a difference in our perceptions of the nature of economics itself. Quoting from his comment,

Right now, low and unskilled workers have very little say – even democrats put the interests of corporations ahead of those workers. How else can you explain democratic inaction on things like illegal immigration and the Chinese unilaterally setting the exchange rate in their favor? Those things keep workers wages low and corporate profits high – which leads to income inequality.

Although I sympathise with his intent, and agree with his comments on the Occupy Wall Street movement, I cannot but disagree with both the underlying statement (that income inequality is bad) or the reason he gives to support this statement (the non-existence of pro-worker policies keeping wages low which leads to income inequality). I’ll focus on the core issue for now and I’ll talk about my views on exchange rate manipulation, immigration, profits and wage rates later.

Now, don’t get me wrong. Income inequality does exist. Perhaps the gap has gotten bigger in recent years. It is certainly perceived to be a great problem by many, if not most people today and it is a metric which still motivates a lot of individuals, like many of those in the OWS movement, to take to the streets, write inspiring tracts or vote in a certain way. All this, I accept. What I do not accept is that income inequality is a bad thing tout court. For the sake of brevity, I will attempt to enumerate the reasons why I think this in a succinct manner. I might then elaborate on one, several or each of the reasons in further posts. My contention is simple: in a free society, income inequality is not bad, and is actually a good thing, for the following reasons:

  1. Someone out there earning a million times more than I do (let’s call him Rich) does not mean that I earn less than I would have if Rich were to earn only ten times more. Economics is not a zero-sum game and it is not true that one person can only gain at the cost of another.
  2. The definition of inequality can be called vague at best. What exactly does “inequality” mean, considering that income equality has never existed at any time in history and that it isn’t even in theory a desirable thing? How much inequality is too much? How much is desirable? Also, income inequality might very well increase even though everyone in society is better off, eg if the bottom 99%’s real income (or purchasing power) doubles, but the top 1%’s increases tenfold.
  3. If Rich is able to support a much more extravagant lifestyle than I do, then that really only affects me psychologically, in the sense that I might become envious of him and his lifestyle. Or it might drive me to produce goods that consumers demand, more efficiently and qualitatively superior than has been hitherto achieved (a great motivator for production and increase of total wealth in society). But we all find happiness in different ways, not only through status-seeking behaviour. The only constant is that our manifold motivations in life are based on our personal subjective valuations of what is important and what is not.
  4. We are all born unequal and inequality is a natural fact of life. Our natural inequality is what drives the division of labour and the enormous explosion of wealth this engendered. As Milton Friedman said, it is unfair that Mohammed Ali was born with a skill that enables him to earn a million dollars in one night, or that Marlene Dietrich was born with amazing legs. But it would have been grotesquely unfair if the rest of us had been deprived of their feats because we are all to be equal.
  5. The luxurious lifestyle of the super-rich and the fact that they have a consumption pattern that differs from the rest of us performs a vital economic function in society. Every product that is currently produced for the masses was at some point in its product history a luxury item, produced for a tiny market of super-wealthy individuals. The willingness of the rich to spend on things which seem superfluous in the eyes of the masses, by virtue of them having more to spend in the first place, in fact drives the process of experimentation and innovation which eventually leads to successful products becoming more commonplace and affordable.
  6. Finally, the fact that someone possesses extreme wealth can, given the absence of government interference, only be the consequence of this person having contributed to society in his lifetime or of his being the beneficiary of a gift of wealth by their predecessor who in their turn must have contributed to society. This because, in a free market economy, one can only gain profits by doing things better than the competition. Income inequality means that a lot of profit is being made and profits are a sign of entrepreneurial success.

In a nutshell, these are my reasons why income inequality is not necessarily bad, and is in fact vital to the continuance of society. I’ll try to elaborate on them in further posts, giving references that support my case.

Finally, I don’t want to create the impression that I am attacking Michael’s views, because it is obvious that he was not talking about inequality itself as a principle, but rather of the effects of pro-labour policies (or lack thereof) on income distribution, which is of course a wholly different thing. I simply used his comments as a springboard for my own ideas on a different subject.

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3 thoughts on “Six reasons why income inequality is good

  1. I actually agree with many of your points. In fact, there was a point in the past where I would have agreed 100%. But as I’ve become older and (hopefully) wiser, I’ve adjusted my opinion.

    I agree completely that some income inequality is a good thing. I would never advocate that secretaries and janitors earn as much as doctors or CEOs. I also agree that just because Rich earns millions it doesn’t mean I’m getting too little.

    To me, it’s more a question of balance and sustainability. In my latest blog post I talk about the rising income inequality since the 70’s. In the 50’s and 60’s the US had a very healthy middle class. A family with one wage earner could live a comfortable life with very little debt. My grandfather supported a wife and 5 kids on a grocery clerks salary – that would be impossible today. Most middle class families require two wage earners and even then many of them have run up huge debts. The US debt to disposable income ratio went from about 65% in the 60’s and 70’s to 130% in 2007. I don’t think that would have happened if wages had kept up with productivity.

    The one point that I disagree strongly with is #6. There are plenty of ways to accumulate extreme wealth without contributing to society. What did Charles Ponzi contribute to society? Or the mortgage lenders that made millions giving out bad loans and then selling them off to investors? Or snake oil salesmen?

  2. galudwig says:

    Thanks for your comment!

    About Charles Ponzi, he was a fraud, and clearly did not deliver on the promises he made, his whole scheme was based on lies and deceit. In a free society with a free market, this would constitute a case of fraud and break of contract, and victims of the Ponzi scheme would be able to sue for losses suffered. The recent financial crisis which you refer to in your second example would be a good reason for getting the government out of the financial sector entirely, as it is very doubtful whether such practices would have happened without the state having interfered in the various ways they did and still do (and if it had happened in a free market, they would have been wiped out in the crash that followed). Lastly, the case of snake oil salesmen is more difficult. They provide a service in the sense that their customers think they are being helped (similar to such practices as homoeopathy, some herbal medicine, faith healers etc..) but in other cases they are clearly fraudulent. I must stick to my claim that, *in the absence of government intervention*, profits can not be sustained if some kind of value is not created for consumers. Profit is made from exchange, and every exchange must be deemed mutually beneficial or it would not happen.

    About your penultimate paragraph, I’ll reply to you in a comment on your website tomorrow or so or write another post when I have some more time to think about your excellent comments and write (sigh if only we all had more time to spend on wordpress right :D). In short, I do not dispute your findings (and actually agree that debt is a big problem but would point to different causes), but do question the metrics used (is average labour productivity a meaningful value that represents actual value productivity as determined on the market?) as well as the underlying statement that wages and productivity must be locked in a fixed ratio with one another, as it seems to imply acceptance of an objective theory of value.. But I need to think this through first and should not give too many premature answers. Thanks again for the comment, I appreciate it and will make some serious posts on the subject later 🙂

  3. […] comment by Michael Lewis on my post on inequality claimed that there are plenty of ways to accumulate extreme wealth without contributing to […]

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