The issue of income and wealth inequality has gained public awareness recently, becoming an important economic problem in our time. Unfortunately, the quality of the public debate about this topic remains very poor. In this piece, I would like to point out three main shortcomings of the problem at hand.
Equality Itself Is Neither Good Nor Bad.
First, people do not differentiate between good and bad inequality. There is nothing inherently bad about inequality, since it’s, after all, only a formal characteristic of the relationship between certain values, like incomes of different people. What really matters is the reason of the inequality. Inequality that results from “rent seeking” and lobbying the government to implement beneficial regulations for the influential and already wealthy interest groups (you may think of banks “too big to fail”, farmers demanding subsidies or domestic industries supporting import tariffs) is obviously bad. Inequality caused by the quantitative easing programs, which increased prices of financial assets held by a relatively small number of wealthy individuals, is also not worthy of praise.
However, inequality resulting from economic progress does not deserve to be condemned, does it? During the Industrial Revolution, workers moved gradually from agriculture to manufacturing, which initially widened the inequality. But this is how the progress happens – it never occurs smoothly, as not all people take advantage of new market opportunities to increase their productivity at the same time. The current upswing in inequality also seems to be driven by technological progress, inter-sectoral reallocation of labour (from manufacturing to services), and globalization. The question whether we should oppose it equals to question whether we should be against progress itself. I hope it’s clear now that inequality may be either positive or negative, depending on its causes, and that the bad ones are not necessarily driven by the free-market capitalism, the favorite whipping boy for all the misery of the world. Instead, it’s crucial to understand that the rise in inequality observed recently in some western countries may result from many causes, including the global economic growth lifting people out of poverty all over the world.
In 20 Years, Almost Everyone Has Made Real Economic Progress.
This leads us to the second weakness of the public debate about the inequality: many people adopt too narrow, Western-oriented perspective. Just look at the chart below.
Chart 1: Change in real income from 1988 to 2008 among percentiles of global income distribution
Source: B. Milanovic, 2013, Global Income Inequality by the Numbers: In History and Now – An Overview , downloaded from Wikipedia .
As one can see, almost the entire bottom 75 percent has seen its real income rise between 1988 and 2008 – and some percentiles made really significant gains. Although it clearly shows that globalization benefited enormous number of people, intellectuals and the press are focusing on the working class in the West, whose real income relatively stagnated. It’s an unpleasant fact for these people, for sure. However, the funny thing is that they are between the 75th and the 90th percentile of the global income distribution, which mean that they belong to a global upper-middle class. From the global perspective, the current buzz about rising inequality is not a sign of concern about the poor at all – it is a worry about the income of an elite disturbed by the increased supply of low-skilled workers from developing countries. Surely, one can criticize the rise in inequality due to globalization – but it implies an assumption that the relative economic situation of the working class in developed countries is more important that the absolute increase in real incomes of Chinese or Indians. It turns out that the authors of Oxfam’s reports and other people who supposedly take care of human misery actually suffer from sinophobia.
Capitalism Has Almost Eliminated Extreme Poverty.
This is connected to the third cardinal sin of the contemporary debate about the income inequality, perhaps the most important one. People often confuse inequality with poverty, although these terms mean something different. The former occurs when people have different incomes, while the latter is when people do not receive enough money. Many people criticize the inequality, but what is really disturbing is not the fact that some have lower income than others, but rather that some have very little.
Fortunately, this is where capitalism enters the scene. Let’s see the chart below, which paints the spectacular reduction in global extreme poverty over the last few decades.
Chart 2: The percentage share of the world population living in extreme poverty, from 1820 to 2015.
As one can see, in 1820 almost all people in the world struggled for less than $1.90 per day. One hundred and fifty years later, still 60 percent of the global population lived in extreme poverty. Since then, the ratio declined to 9.6 percent. It means that billions of people have been taken out of extreme poverty. This progress is mind-blowing, especially for people who blame capitalism and ‘neoliberalism’ for the rise in inequality, although it is hardly surprising for economists who know that free markets enable economies to grow. Indeed, poverty was the default state of the humanity. What enabled for its reduction was simply to let poor people get richer by protecting property rights, liberalizing markets, and freeing trade.
This is how capitalism works: it generates wealth through free exchanges and accumulation of capital which increases the labour productivity. Therefore, the call for the greater economic equality for its own sake not only diverts us from the issue of poverty, which is the real problem, but it may be even counterproductive and hamper the economic growth — the only genuine means of eradicating poverty.