How Big of a Deal Is Income Inequality? A Guest Post

Retired neurologist William Bernstein is probably known for his investment books The Intelligent Asset Allocator and The Four Pillars of Investing. His two latest books, A Splendid Exchange: How Trade Shaped the World and The Birth of Plenty, deal with the history of world trade and economic growth, subjects he has agreed to blog about here.

How Big of a Deal Is Income Inequality?

by William Bernstein

A Guest Post

For nearly all of human history, the lot of the average person improved not at all. Then, about two hundred years ago, the material well-being of the planet’s inhabitants began to grow at about 2 percent per year.

Although this may not sound like much, it means that the life of a child is nearly twice as prosperous as that of its parent; over a century, the standard of living increases sevenfold. Today, per capita G.D.P. is higher in Mexico than in the world’s wealthiest nation in 1900, Great Britain.

The paradox of economic growth is that the same mechanisms that create great wealth –secure property rights and rule of law guaranteed by an independent judiciary — also give rise to great inequalities in its distribution. Private property provides a powerful incentive to produce wealth for oneself while simultaneously denying that same wealth to others. Wealth does trickle down to the rest of the population, but often not fast enough to avoid political strife and worse.

The reason for this is simple: if individuals cannot keep enough of what they earn then they will not produce. If, on the other hand, the most productive do keep what they earn, significant inequalities inevitably result.

Further, in a technologically driven world where an individual’s unique talents can be scaled up to an almost infinite degree, inequality increases dramatically.

For example, researchers Thomas Piketty and Emmanuel Saez calculated that between 1972 and 2006, the portion of income earned by the top 10 percent of the population rose by half; for the top 1 percent, meanwhile, it doubled; and it quadrupled for the top 0.1 percent. For the top 0.01 percent, it rose sevenfold. The current disparities are nearly identical to those of early 20th-century American robber-baron capitalism.

Economic libertarians argue that this growing inequality is unimportant: aren’t the poor of 2008 still far better off in terms of real income, health, life expectancy, and material comfort than even the richest citizen in 1900?

The fallacy of this argument is that human beings do not measure their well-being by absolute real income or longevity — but rather in relative terms. To paraphrase H.L. Mencken, a wealthy man is one who earns more than his wife’s brother-in-law.

Further, a growing body of research reveals that the social and medical costs of inequality are high. Here is the tiniest of samplings:

• Among both American states and Canadian provinces, homicide rates closely track income inequality, even after the absolute level of income itself is carefully controlled for. That homicide is not driven by poverty alone is demonstrated by Canada, where, because of aggressive redistributive policies, the poorest provinces have the lowest inequalities and also the lowest number of violent deaths.

• It is becoming increasingly obvious among obesity researchers that the primary underlying factors in this epidemic are social class and income inequality.

It is no accident that the U.S., with the highest income inequality among the world’s developed nations, also has the highest incidence of obesity and its attendant comorbidities: diabetes, hypertension, and vascular disease.

Obesity may also be the reason that the U.S., ostensibly the world’s wealthiest nation, ranks 29th in life expectancy, right behind Jordan and Bosnia. Those who think that these problems are primarily the result of voluntary lifestyle choices should reflect on the difficulty of providing a family of four with fresh fruits and vegetables on a minimum wage salary.

Worse, extreme income and wealth inequality alone may hinder growth. After all “respect for property rights” is really, in most cases, shorthand for “respect by the have-nots for the property rights of the haves.” If those on the bottom rungs do not feel that they are getting a fair shake, the very bedrock of our prosperity crumbles into social and economic apartheid as millions of Americans flee to gated communities, millions more are required to staff the burgeoning private security industry, and yet more millions fill our prisons.

This is likely the reason why supply-side economics fails in the real world. Cross national comparisons in developed nations, for example, show no correlation between tax rates and economic growth. Further, the “golden period” of growth in the years before 1973 occurred in an environment of higher tax rates than in the lower-growth 1980′s and 1990′s.

More ominously, several data sets now connect high national income inequality with low growth. Correlation is not causation, and clearly, much more research is called for.

But these data should give pause to those who are complacent about increasing income and wealth disparities, and who further believe that reducing the top marginal income-tax rates and eliminating the “death tax” leads to economic Valhalla.

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  1. Neil (SM) says:

    Those 12th century American Robber Barons must’ve had it made up until the Mongols invaded.

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  2. the Gooch says:

    “The current disparities are nearly identical to those of early 12th-century American robber-baron capitalism.”

    Shouldn’t that be 20th-century?

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  3. Joe D says:

    Another flaw in the libertarian argument is that those who keep most of the profits are not necessarily the truly productive ones. They may have been so earlier in their careers and put themselves in a position to profit on the productivity of others (“I got mine, Jack, and now I get some of yours, too”). Whether this is fair or not is moot.

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  4. Stephen J. Dubner says:

    @1 and 2: Um, yes, sorry; typo now fixed. Thanks

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  5. RNB says:

    Throughout history many have aspired for a little piece of land to call your own. Not an apartment, but land. Something that “could” give a degree of self-sufficiency in the event of economic collapse. It’s basic security. Regardless of number of bedrooms or TVs or iPhones in the home, it could be argued that natural history is a natural right. If so, inequality inevitably reduces median utility, regardless of conservative justifications.

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  6. Mercutio.Mont says:

    “After all “respect for property rights” is really, in most cases, shorthand for “respect by the have-nots for the property rights of the haves.””

    I would argue that such a statement is only true if the enforcers of property rights are corrupt.

    A less corrupt property rights system would permit me the “have-nots” to sue the “haves” when the power plant owned by the “haves” causes harm to the “have-nots.” The fact that such doesn’t happen – or at least doesn’t happen often – is a direct result of corrupt property rights enforcement.

    Author also fails to acknowledge what economic libertarians really say: That it’s immoral to take what is not yours – whether it belongs to someone in the .001 percentile or in the 90th percentile. And also, of course, the practical problem of reducing growth by removing incentives for success.

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  7. Steve says:

    I don’t think that anynoe begrudges the truly productive from having more. Unfortunately, over the centuries, this has seldom been the case and in 21st century America has almost ceased to occur. There needs to be a reallignment away from speculation and financial manipulation to real investment. Lower taxes are actually the enemy of real investment since with more dolars running around chasing a high return, the easy way to achieve this is to buy the assets that all the other wealthy people are.

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  8. gp says:

    I strongly agree with the author. European public policies that benefit the poor are more than offset by lower security and prison costs. European corporate welfare for national champions as well as middle class access to social programs explains these nations’ high level of public spending as a percentage of GDP.

    As a society, we would be far better off spending cash keeping the poor well-housed and their children well-fed. It would cost so little to extend the Section 8 program and allow poor families to move into suburban neighborhoods with good public schools. Furthermore, this would free up urban real estate currently wasted on crime-infested public housing. I also believe that it would be cheaper to pay welfare benefits forever and give poor people some stake in society rather than force them to get jobs or engage in community service (Clinton’s terrible Welfare Reform). I would rather spend money keeping these people in their new suburban homes rather than building and operating even more prisons. This, along with a reformed drug policy, would result in US cities becoming clean, safe and wonderfully family-friendly.

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