Equality or inequality: a non-conforming economist`s view

IMGP1357There is a lot of debate, misunderstanding and debatable conclusions about inequalities in income and wealth so it is time to look at the facts and the myths.

Starting with wealth, and depending on what is in and out of the calculation, there is a very uneven distribution of wealth in almost all societies that accommodate private property rights. We often hear that 10% of the population own 80% or even 90% of the wealth. Even if this is correct I would argue that it is not necessary to do anything about it. People have, inherited wealth, been lucky, worked hard, are old, were in the right place at the right time, won the lottery: so what! There is very little that can be done to help the economy by trying to redistribute wealth except where it was obtained illegally. The reasons for this are:-

  • Wealth derives only a small proportion of the income that determines standards of living.
  • Income derived from wealth is a better target for tax
  • A tax on wealth gradually destroys the source of the tax
  • It can break-up capital and remove efficiencies gained by economies of scale
  • It can impact negatively on growth and job creation
  • It can take away the incentive to invent and innovate

For many years the mantra that “10% own 90% of the wealth” has been used to argue for a redistribution of income. This is of course a non-sequitur as the argument for redistributing income should be derived from the unequal distribution of income not wealth. In fact income statistics are much less supportive of redistributive polices which is probably why those who argue for redistributive policies make the link between an unequal distribution of wealth and the need for a more equal distribution of income.

Again depending upon what is in and out of the calculation the top 10% usually receive between 20% and 30% of income in most democracies. Although there is a considerable difference in the data when comparing gross incomes and net incomes after tax and benefits are taken into account. Arguably it is this very inequality that is the engine of growth as it provides incentive and fulfils the aspirations of young people by giving them a direction to build their career. In addition to this it brings about a more efficient allocation of resources to labour markets, and because the distribution of income is forever changing it reflects changing patterns of consumption and opportunity. In contrast, the distribution of wealth tends to change much less overtime.

A very interesting set of statistics that I came across in the late 1970`s, (and I can no longer verify the source so perhaps someone reading this may be able to confirm that I did not dream these numbers), illustrated the importance of free market capitalism in creating equality of income. Alongside this it also illustrated a huge government deception.

The statistics compared the ability to consume goods and services as an imprecise, but useful, measure of living standards. This was difficult to do as two of the counties were communist command economies who did not provide easy access to information. The statistics compared the top 10% with the bottom 10% in four countries. The countries were:-

  • China
  • USSR
  • UK
  • USA

And the ratios, in order, of the top 10% to the bottom 10% were:-

  • 22/1
  • 16/1
  • 4/1
  • 2.5/1

So in China the top 10% were twenty two times better off than the bottom 10% and in the USA they were two and a half times better off.

And what was even more fascinating was that revolutions in the USSR (1917) and China (1949) had been undertaken to create equality and the USA and UK had remained capitalist economies, and we all know that market capitalism is not noted for its aim to create equality. The Chinese and Soviet revolutions had created an equality of wealth over night by removing private property rights, but entrenched an inequality of living standards on their population with no incentive to change as the decision making political elite were in the top 10%. This is the “huge government deception” referred to above. In contrast, freedom of contract, respect for private property rights, the profit motive and free enterprise were the very things that were turning an unequal society into a much more egalitarian society.

Since the 1970`s in the UK it is certainly the case that the distribution of disposable income has become more unequal, but we should not automatically jump to the conclusion that this is bad for the economy in the same way that we should not assume it has been good for the economy. If we are talking about the necessary distribution of income that will produce the highest rates of economic growth and sustain the fastest growth in living standards over time, then like many things in economics we know that it is there, but we cannot prove what it is. It is likely that when, in the 1970s, high marginal rates of income tax were 98p in the £ that this was a disincentive to work and had a damaging effect on growth. However it is not clear whether current rates of tax are too high, too low or just right. All we can say is that the issue needs to be debated openly.

Final thoughts:-

  • The best way to create a more equal society is not to try and create a more equal society.
  • Free market capitalism is the best engine for growth and the only proven way of creating equality.
  • There is a limited role for government which is to collectively purchase the non-rival, non-excludable public good and provide support for the merit goods of education and health.
  • There needs to be a legal framework for supporting a free and fair competitive economy where government acts as a referee, not as a player
  • A tax system needs to ignore the uneven distribution of wealth and concentrate on a minimal redistribution of income that genuinely helps the poor and disaffected. In doing this it is necessary to recognise that inequality of income is an essential driving force that makes us all better off by incentivising labour and allocating and reallocating resources to where we most need them.

John Hearn 19/6/15

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2 thoughts on “Equality or inequality: a non-conforming economist`s view

  1. Hi John

    I enjoyed this article. I’d like to challenge you on something, though.

    Your argument appears to rest on the (apparently sound) premise that a Free Market promotes equality. That’s easy to accept, if we can agree on the definition of equality.

    But what if we have an “almost-free” market? What if the market conditions are such that it appears to be close to a Free Market, but is ever so slightly manipulated, regulated or structured such that it is disproportionately difficult to move beyond the most basic levels of purchasing power? While at the same time the earnings of those at the top were allowed to increase to extreme multiples of the lowest earners’ wages.

    There’s plenty of anecdotal evidence that I keep coming across that life is more expensive, and things are just harder, when you’re poor. If you earn a decent salary and you go overdrawn, you get a polite text from your bank and maybe pay a little interest at the end of the month. If you’re poor and you go overdrawn, you could get charged £25 for not having any money. Basics that everyone has to pay for take up the vast majority of a minimum-wage earner’s income.

    If we’re talking about income equality, that equality must derive from some notion of economic justice? If equality is supposed to be an objective of society (but not, as you say, of Capitalism), that would imply it is either ethically or economically (or ideologically?) mandated in some way by that society’s (possibly elected) leaders or its collective will.

    What I’m trying to get at is that if some degree of equality in purchasing power is to be desired – just enough that there is an equal gradient of difficulty in reaching the higher levels of purchasing power and a better standard of living for those with the lowest labour capital – then do you not think our lawmakers have an obligation to remove obstacles in the way of people moving up the income ladder?

    Notice I kind of switched to purchasing power. I think this is at the centre of how I think of income inequality. For me, income inequality is a bad thing when a person earning minimum wage is able to afford only the most basic standard of living with no hope of saving, and no margin to take risks that might enable them to increase their capital.

    These people do not increase their spending power year after year. They don’t build wealth of any kind. Just debt. They don’t consume more, just as little as possible at slightly higher prices with slightly more income. The only way to build capital is to get paid more, and that’s a difficult thing to do when you’re told there’s an oversupply of your kind of labour.

    Since we simultaneously have the top earners making hundreds of times the minimum wage, it seems to me that if income equality is one of a society’s goals and that this drive for equality arises from an attempt at social justice, then that society should promote a better standard of living and higher social mobility for the lowest earners.

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  2. Excellent response to the article and I agree with what you say. In my article free market capitalism is both an ideal that has yet to be achieved and a work in progress that still produces greater equality than any other managed system of resource allocation. To improve upon the current system we need government limited by law and a regulatory system that levels the playing field and removes almost all barriers to progression through and between labour markets. Too many barriers exist which preserve income inequalities that are undeserved and not accessible to everyone.

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