Dealing with Wealth Inequality

 

“A society that puts equality before freedom will get neither. A society that puts freedom before equality will get a high degree of both.” — Milton Friedman

Wealth inequality is the crux of modern progressivism and democratic socialism. They contend that free-market capitalism moves wealth to the top — leaving the rest at a loss for cash — and that the government must intervene to redistribute wealth from the bloated top to the destitute bottom. This is for good reason: It lends itself to scary-looking graphics such as this:

Inequality is inherent to the capitalist system, but that doesn’t necessarily explain why it’s such a big topic for the Left. After all, most people expect wealth inequality, and think it a good trade off for better standards of living. The reason the Left uses wealth inequality is that the differences are enormous. When people see graphics like the one above, they are swayed into believing that the benefits aren’t worth the costs. If the rich are really that rich, what possible “unintended consequence” could outweigh the gains to be had in plundering them and distributing their fortunes?

The typical capitalist argument — that a smaller slice of a bigger pie is still more pie — is a good explanation, but still grates against people’s sense of justice when the numbers are this skewed. A further explanation is required.

How Should We Respond to Wealth Inequality?

It’s less a matter of there being a single, definitive answer, than a combination of them. The first thing to tackle is what these graphics leave out: primarily, social mobility. While skewed distributions can make it seem that all the wealth is in the hands of a few one-percenters, it neglects to show the shifting of whom those one-percenters are, and how people shift across the wealth distribution through time. For instance, a study by the University of Michigan — discussed here by the Dallas Fed — showed that 95 percent of households that were in the bottom quintile of income in 1975 had moved up by 1991. Over time, most people see an increase in their absolute wealth, and the bottom of the distribution is filled by young people and immigrants whose fortunates almost always improve with time. This mobility cannot be ignored.

In a free market, this makes sense. Most people start their economic lives poor and often take out loans, giving them a negative net worth. However, as people acquire assets over time, they move up the distribution. There are a few elites, but — by the nature of the free market — their success comes from providing benefits to others, so tearing them down to the “normal” level costs everyone else. Keep at that long enough, and there’s soon no one left to plunder.

This explains why the skew might be more than one would initially expect, but not why it would be what is often claimed. There is some credibility to the claim of increasing inequality, but the culprit here isn’t capitalism, but the march toward socialism.

This cuts to the core of the Left’s dogma. How can socialism — the darling of equality cause inequality? Indeed, socialists are so enamored with equality, that they have essentially made it axiomatic that socialism creates equality. But why would this necessarily be so? Have they never bothered to put two trends together: i.e., a trend towards greater inequality in the last 40 years, and a concurrent trend towards socialism?

To understand why socialism has created inequality, you have to understand how workers gain more income. In a market economy, a worker’s income increases with the demand for his skills among potential employers biding for his labor. Eventually, the wage reaches an equilibrium where the highest offer isn’t in excess of the value he would add.

Socialism, however, gets in the way of this. Taxes, tariffs, and regulations all make business more difficult and reduce the number of companies who can stay afloat. With fewer potential employers competing for our worker’s labor, he’s more likely to get stuck with the first (and lowest) offer he receives. Multiply that across an economy, and you get inequality and mobility stagnation.

The irony is that socialists’ main argument against capitalism — that free markets allow powerful monopolies and oligopolies to form — applies at least as powerfully to their own preferred solution. That is, as regulations and government interference increase, the only companies able to survive are those with the size, political influence, and legal budget to get by. And so we end up with a few one-percent companies courtesy of socialism, and significantly less competition in the labor market.

In short, the increasing extremes of wealth inequality can be correlated to the socialism in our system. In contrast, the moderately strong inequality of the typical free market reflects social mobility, which is a reasonable trade-off given the increase in absolute wealth it creates.

So will electing Sen. Bernie Sanders result in an explosion of wealth inequality? Probably not. If the government chooses to go after wealth inequality directly, they will find a way of strangling even the wealthiest, best-connected companies, which would damage production.

The lesson to be learned is that wealth inequality is a by-product of the mix of socialism with capitalism. There is enough socialism to destroy competition, but enough capitalism for there to be wealth left to accumulate. Furthermore, wealth inequality — despite the ramblings of Senator Sanders — is not our biggest issue and is not causing chronic problems. Rather, it is a symptom of the many complications that result from a mixed-economy.

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  1. The Question Inactive
    The Question
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    Kate Braestrup:

    Presumably, they pay him bazillions because he makes bazillions for them, right? So —provided we tax him at some appropriate level— what’s the problem with him making a small fortune doing work that sounds so incredibly boring to most of my family members that we wouldn’t do it for all the money in the world?

    Yes.  If a corporation invested in, for example, a new computer system that costs $10 million per year to maintain, but improves productivity resulting in $50 million per year increased profits, I think no one would complain about that.  But if a CEO gets paid $10 million a year, that’s seen as unfair.  The only legitimate question should be, “Does the CEO increase profits more than what he is being paid, and by how much?”

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