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Income Inequality, Fair or Unfair?

is income inequality good or bad; should it be accepted and encouraged, or suppressed?

Overview

Many of the world’s leaders believe income inequality is the greatest problem facing the modern world. Conservatives may defend income inequality as the result of hard work by some and laziness by others while Liberals frequently rail against inequality as a great injustice caused by greed. Is one right and the other wrong, or are they BOTH RIGHT and BOTH WRONG?

Makers vs. Takers at Occupy Wall Street

LearnLiberty.org

The difference between those who create wealth and those who take it; why the solution to Wall Street is stopping the takers, not making the “Occupy” crowd takers too.

This page, along with its related pages, addresses important questions about income inequality, including:

Is income inequality actually rising in the world, and in the United States?
What does it mean if it is rising?
What are the causes of income inequality and does the cause matter?
Are there different kinds of inequality, some good and some bad? And, if so, what should be done about each?
Is income inequality a useful measure of a society’s well-being and fairness?

Elusive Meaning

Why do some of the world’s richest and poorest countries both have some of the highest income inequality?

In a recent analysis the United States was noted to rank worse than Nigeria in inequality. Does this mean that Nigeria is a better place to live if you are poor and that the United States is doing a terrible job of “sharing” the wealth?

Consider the following facts from Income Inequality by Country

Romania has very low income inequality and very low “economic prosperity”
Botswana has very high income inequality and very low “economic prosperity”
Switzerland has low income inequality similar to Romania but very high “economic prosperity”
Hong Kong has high income inequality similar to Botswana but high “economic prosperity”

Clearly there is no clear relationship between income inequality and economic prosperity in different countries, because income inequality can be caused by many different factors.

Part of the difficulty in understanding income inequality is the faulty yardstick used to measure it. That misleading tool is called the Gini Coefficient, and it is used by virtually every major national and international organization. But the Gini Coefficient indicates that things are good when everyone is equally poor, and that they are bad when everyone is unequally but universally more prosperous.

Fair and Unfair

Depending upon what is producing income inequality, it can be unfair and destructive or fair and constructive. Both TAKERS and MAKERS increase income inequality and both are operating at the same time in the same society. Unfair income inequality is the result of upward wealth transfer or theft, taking from the poor and making them poorer, while fair income inequality is the result of making new wealth in the form of new or better goods and services that improve the life of everyone, making the poor richer along with those who create the wealth. The former are deserving of condemnation, while the latter should be respected and promoted.

Historically, unfair income inequality was created by kings and dictators who used their armies to extract wealth from the weak and give it to their supporters. Today, politicians take wealth through taxes and give it to their supporters (including rich businessmen and special interest groups), through bank bailouts, loan guarantees, or special privileges or protections in a not-so-free market. In such societies, corruption rather than production is the source of wealth.

Fair income inequality, on the other hand, is the result of talented people creating higher quality goods and services for lower prices, or inventing new products like the iPhone that enrich people’s lives. If they do it honestly, without using government favors or privileges, the resultant “inequality” is simply an extension of personal talent and drive. It is said that “they didn’t build it” because they used the public infrastructure, but in reality, the taxes paid by successful corporations and by all the people they hire are what builds and maintains the infrastructure and that without the creativity that creates productive jobs, there wouldn’t be money for roads and schools.

In the process of creating wealth, the producers get to keep only a small portion of the benefits they provide. Bill Gates created Trillions in benefit through increased productivity for the world’s corporations and households, but only got to keep billions, much less than a penny for every dollar of wealth he created. And he only got that long AFTER the benefits of his work became common knowledge.

Entrepreneurial effort is the source of the world’s wealth. It creates income inequality but without it there wouldn’t be much income.

Recognizing the difference

Recognizing the differences between fair and unfair income inequality is critical if we are to eliminate the corruption that creates unfair income inequality without the incentive-dampening effects of redistribution that have destroyed fair income inequality and the prosperity it creates, along with the unfair income inequality. Differentiating between the two can be particularly difficult in modern society because both good and unfair income inequality can be increasing at the same time because both makers and takers are actively pursuing their goals. It is imperative to attack unfair income inequality, and imperative to NOT attack fair income inequality.

The key is to see how the wealth that is creating the inequality is being generated. If the wealth is being taken by force, then it is unfair and should be condemned. If the wealth is being created by improving the quality of life of the people through entrepreneurial innovation and creation without government favors, it is fair and just and should be admired and supported.

Quality of Life

The entire political class uses a faulty measure of the quality of people’s lives called the Gini Coefficient of Income Inequality that considers countries where everyone is equally poor to be good (a high Gini coefficient), while countries where everyone is better off, but unequal, are considered bad (a low Gini coefficient). A better measure is needed to determine whether the quality of life for the people is rising or falling, whether they're improving toward greater prosperity or going backwards toward greater poverty.

Lesson

Because income inequality is so common and controversial, it's crucially important to understand why it exists, how it develops, and what should be done about it. Natural inequality is an inescapable fact of life. People are born with different abilities and in different circumstances that naturally lead to material inequality. Is this good or bad? Should it be encouraged or should government try to eliminate it? The answer depends upon how the wealth that created the inequality was accumulated. If the wealth was acquired dishonestly through corruption of political power, the inequality is unfair and destructive, but if the wealth was acquired honestly by producing and sharing new wealth, it is fair and constructive.

Instead of just making a blanket denunciation of all “the rich”, we need to consider HOW they make their money - whether in the Free Market or the Crony Market - and remember that concentration of wealth will only lead to dangerous concentration of power if politicians can be bought and favors can be purchased. If we followed the rule of law, where everyone is bound by the same just laws, wealthy and less wealthy alike, and no one can “buy” power, the only way anyone can become wealthy is to do something that others will voluntarily exchange their money for, because it makes their lives better.

The key to appropriate policy is recognizing the difference between fair and unfair income inequality, because one deserves condemnation and the other admiration. Failure to make this distinction will almost always lead to misguided policy that destroys prosperity for all, not just the rich.