Confusion about Income Inequality

I suggest that libertarians and conservatives challenge the use of term “inequality” unless the *kind* of inequality is specified. Otherwise you accept the leftist idea that there is a single quantity, income, that every person’s utility depends on and ignore trade-offs.

Suppose, for example, there are two married couples, in which all spouses are earning $50K annually. After having children, one wife chooses to stay at home and the other continues to work. Looking at income alone, “inequality” has increased, since one couple now has double the income of the other, but the couple with the housewife is not worse off overall than the other couple, since they have decided that the wife being at home is worth more than $50K.

Here is another example of ignored trade-offs. University professors decry inequality of income in part because they envy the higher salaries of businessmen, but they never mention their greater job security and freedom to publish their work. Academics trade off income for security and intellectual freedom.

How does an increase in inequality mean that income was shifted from poor to rich? It doesn’t. An increase in inequality tells us nothing about income shifts.

This is what I don’t understand. Why do so many of the income inequality commentators think the rich are getting richer by preying on poor people, rather than by preying on other rich people? Why would someone wanting to get rich, or someone who is already rich and wants to stay rich, spend their time going after people who, by definition, have no money?

Technology is one of the best places to see this. The first televisions were expensive, and by today’s standards, extremely poor quality. But rich people bought them, and over time the quality improved while the price fell. Now even poor people have televisions. I wasn’t there to witness it myself, but I’m willing to bet the first guy to market an extremely expensive, 6″ black and white television wasn’t thinking “Just think of all the poor people that will line up to throw their hard-earned money away on this.” while twirling his nefarious black mustache and adjusting his monocle.

Pick any appliance or technology produced in the last 60 years and you will see this. Novel and expensive inventions aren’t marketed to poor people, though poor people may eventually own them once rich people have invested enough of their money into being early adopters.

What if psychological well-being is driven more by relative status than absolute status? Isn’t it then possible to make society worse off as a whole by making everyone better off in a very unequal way? I see lots of evidence that confirms this. When 99% feel inferior to 1% (and further often feel that the 1% have benefited from hidden subsidies) it is possible that well-being has declined. Perhaps this is why all sorts of confidence measures are far down from previous levels despite everyone being monetarily “better off.”

“This is what I don’t understand. Why do so many of the income inequality commentators think the rich are getting richer by preying on poor people, rather than by preying on other rich people?”

Brian E.,

People think this because old stereotypes die hard. Prior to the rise of free-market capitalism, one of the few ways to get rich was to take from the poor. Capitalism made this approach unnecessary and unattractive, but most people have a hard time recognizing the difference. Of course, this confusion is strongly linked to the fact that some people can profit politically by perpetuating that stereotype, so it continues to be accepted.

A similar stereotype exists with regard to the term “poor.” To most people this term implies economic destitution, but based on this standard almost no one in the U.S. is poor. Since this stereotype is useful for certain political purposes, it continues to be propagated.

David,

Your point about income shifts is the right one to make. If “inequality” is increasing because the rich are growing their incomes faster than the poor, then it may very well be a good thing. After all, doesn’t this mean that everyone is doing better?

And like Bill, I’m not sure I agree with GI’s point about aggregate demand. When the wealthy “save” their income, they are usually investing it. And where do invested funds go? To pay people to create something new. The money isn’t disappearing from circulation, as if someone were hiding it in a closet, so there should be no drop in aggregate demand. I don’t get this argument at all.

Saul Alinsky said we should focus on income inequality as a means to increase social unrest. That is what I see happening in the political arena while the media and other uninformed people talk about it because it “feels good” that people should have more money.

This really isn’t an issue at all.

We don’t live in a zero sum world so the income you have does not come at my expense. As we have seen in the data with inequality of income between men and women, much of the inequality comes from the types of jobs women gravitate towards.

When you have the poor living in a home with electricity and heat and food on the table and a color television and cel phone it is hard to worry about inequality. It seems the focus on income inequality is just a political guise to convince the public that we need to tax the “rich”. Unfortunately, many of the supporters of that idea one day wake up and find out that they have been deemed rich.

The income inequality debate is one I hate. But to start with a quote from a Ronald Reagan, “you can make the rich poor, but you cannot make the poor rich.” This is another way of saying it is not a zero sum game, and policies designed to reduce income inequality will reduce the income of the rich (and middle class) but not increase the income of the poor.
Compare Sweden and the US. In an article written by the Coyote blog writer, he does a chart showing on a ppp basis what % of the population of Sweden (with its extensive policies designed to reduce income inequality) is better off than the US population. Basically it is the bottom 5%. So the top 95% of the US population is better off than the top 95% of the population of Sweden. Now let’s think, do Sweden’s schools and students rank higher on international charts than those in the US (yes), does more of the population of Sweden exhibit math and language skills at high levels (yes), do they waste less money on defense than does the US (yes), are they less corrupt than the US (yes), and do Swedes in the US have much higher income than average Americans and those left behind in Sweden (yes). So with the same policies it is likely that 100% of Swedes would be better off than Americans. But with their policies focusing on income inequality, they have made their top 95% poorer so that the top 95% of Americans are better off.

Julien Couvreur, you’re radical. I’m moderate. It is great if I can quantify phenomenons, but rarely I can, and if I cannot, i could still know something.

A lot of truly excellent comments above. Cheers to Henderson for addressing this topic, which can be difficult and frustrating as so many typically view this as an issue of “fairness”. It is vital to keep pointing out that unequal outcomes are not simply a matter of unfairness. Those on the left all too often use income inequality to declare the failure of free markets (which to me makes no sense).

@Roger Koppl,
I read your piece. Excellent. BTW, is there a verb missing from your second-last sentence above?
So here’s how I would say it in the future, now that I’ve read your piece:
I don’t care about income inequality per se. What I oppose is the various government programs that increase inequality, such as the drug war, the para-militarization of police forces, lousy government schools, and occupational licensing.
What do you think?

I second the recommendation for Roger Koppl’s excellent piece. But why stop with the short list?

You should add bigger fish such as Medicare, Social Security, the SEC, and the Fed.

The Fed benefits the rich as an accident of how it operates. If it could helicopter in new money, that would be better. But then there would be the problem of helicoptering it out when it wants money to tighten. The SEC, however, is simply a pure sop that keeps the richest on Wall Street rich by making sure they get to trade on new information first.

But even these are small potatoes compared to Medicare and Social Security. By not being severely means tested, these do nothing but take 15 cents of every dollar the poorest worker makes to protect the savings of the the richest age cohort until it is inherited by the second richest age cohort.

Frankly, anything government does that isn’t specifically targeted towards the poor will necessarily increase inequality because it either benefits directly or flows through the hands of those whose incomes are above median. This includes even legitimate government functions such as defense and courts.

If you want more income equality, you want (a) more turnover at the top and (b) less funneling of money toward the top. For both, you need smaller government.

Thomas Boyle, your examples are valid and interesting. However, the claim “statements like ‘$1 helps to poor more than it helps to rich people’ should be avoided” is indeed very radical; it is some kind of taboo. It is hard to justify that. You should show that “$1 helps to poor more …” is necessarily wrong or meaningless or unprovable. I think you haven’t that. Also, you asked “if the dollars are worth less, why do rich earn more of them?” There are many reasons. Luck, talent, effort, incentives, unscrupulousness? Where are we going with that?

@David

I don’t disagree with the majority of the post, except this sentence is definitely inaccurate: “You could have everyone’s income growing and yet inequality increasing, as, in fact, has happened over the last 30 years.”

No, everyone’s income has NOT grown over the last 30 years. For many working class Americans, that number is stagnant at best and dropping at worst. Add to that the twenty- and thirty-somethings who don’t even show up if you go back to 1984 but only the past 15-20 years and the income numbers are even worse.

I could easily be guilty of nitpicking, except this sort of level of factual detail is what you bring to GI’s article (which I have no problem with doing by the way).

“There are various indirect effect of redistribution, some bad, some good.”

Pajser,

David Summers is right. Let’s put it this way. Redistribution has the effect of giving money to people who have done nothing for it. They have not created additional value nor increased productivity. How do we know? If they had, someone would have been willing to pay them for it. When people receive money through the free market, it’s because the provided something of value. When the money is redistributed by the government, the transfer occurs without the production. This is a net loss to society and, frankly, a net loss to everyone, including the poor.

“It seems obvious that poor people are better off after redistribution.”

Pajser,

Yes, they seem better off in the short run because they have more money. But in the long run it doesn’t make them fit for anything besides being on the receiving side of unearned largesse. If they can get by simply by being, AND since they risk losing the payments (in some cases) by earning too much, they have little motivation or confidence for improving their lot. This is terribly destructive of their dignity and potential. So yes, it’s a net loss for poor people.

Regarding the value of a dollar, I think it’s correct to say that the marginal value of a dollar is higher for a poor person than for a rich one. But the value to society as a whole is the same–society doesn’t care who spends the dollar as long as it’s spent. So there’s no gain to society based on redistribution alone. Even worse, a high proportion of the money spent by the poor goes for consumption, which is a wealth-destroying activity. The wealthy spend a relatively large proportion of their money on investment, which is a wealth-creating activity. It seems, then, that society benefits greatly by keeping money in the hands of those who create wealth. This is exactly what the free market does, provided the government has the sense to keep out of it, beyond providing protection for property rights, of course.