Saturday, January 11, 2014

What is the problem with income inequality?

Click to view larger graphic.
Since Pope Francis promulgated Evangelii Gaudium, with its infamous passage on “‘trickle-down’ theories”, conservatives — especially conservative Catholics — have been rather touchy.

Most of them aren’t driven by their own personal greed. Many if not most aren’t even wealthy, but rather solidly part of the middle class. For the most part, they’re good, well-intentioned people … even the disciples of Ayn Rand. And most are well aware that capitalism rewards some ugly human traits even given positive legislation and effective regulation. They don’t defend the ugliness or the weaknesses; they simply hold that capitalism works better than do communism or socialism.

But while the increase of the “wealth gap” has been a source of some concern for a while now, from recent conservative reactions, you would never have guessed that anyone spoke of income inequality before Francis. “But what IS it exactly?” asks my friend Elise Hilton. “Does it mean that a teacher, a brain surgeon and a garbage collector should all earn the same wage? Does it mean the wealthy entrepreneur should simply give away her money, rather than investing it or leaving it to her heirs?”

These must be rhetorical questions. After all, with the exception of a handful of leftover Communists still dreaming in their academic refuges, liberals accept that different jobs will merit higher or lower wages. No one has a problem with entrepreneurs investing their income or leaving it to their kids; in fact, no one has a problem with people becoming or remaining rich.

It’s important to stress this because some writers, such as Pat Buchanan, dismiss the inequality issue as an attempt to ramp up class warfare based on envy of the wealthy. While this might be the case for some liberal politicians, the dismissal itself is an ad hominem; calling an opponent’s motives into question doesn’t disprove his argument or render it less credible.


Graphic Source: Washington Post.
The problem with using either “income inequality” or “wealth gap” as a shorthand is that both are essentially misleading; they both create the impression that the issue is about the fact of inequality rather than the degree of inequality. Hilton quotes extensively from AEI fellow Jonah Goldberg, who, having been misled in such a fashion, goes on to create further distortions:

As a broad generalization, liberals see income as a public good that is distributed, like crayons in a kindergarten class. If so-and-so didn’t get his or her fair share of income, it’s because someone or something — government, the system — didn’t distribute income properly. To the extent conservatives see income inequality as a problem [my emphasis], it is as an indication of more concrete problems. If the poor and middle class are falling behind the wealthy, it might be a sign of declining or stagnating wages or lackluster job creation. In other words, liberals tend to see income inequality as the disease, and conservatives tend to see it as a symptom.

In fact, the increase of income inequality is a symptom, as are declining wages and lackluster job creation. But unless you first recognize that income inequality is not the ideal state of affairs, even though a certain degree has to exist for an economy to work (making it a kind of “necessary evil”), then you won’t recognize its increase as symptomatic of a brewing economic crisis.

In December 2008, Paul Krugman wrote in the New York Times, “There’s no obvious reason why consumer demand can’t be sustained by the spending of the upper class — $200 dinners and luxury hotels create jobs, the same way that fast food dinners and Motel 6s do. In fact, the prosperity of New York City in the last decade — largely supported off of super-salaried Wall Street types — is a demonstration that you can have an economy sustained by the big spending of the few rather than the modest spending of large numbers of people.”

Krugman was either talking tongue in cheek or talking through his hat (to use the more polite expression). Not only can the rich not consume enough to support the rest of the economy, their wealth depends on the consumption of the rest of the population. The super-sized salaries of men like Tim Cook, Michael Duke, Alan Mulally and Irene Rosenfeld depend on millions of little people like you and me buying iPhones, shopping at Wal-Mart, leasing Mustangs and eating Kraft Macaroni and Cheese. What’s more, the rich know it, too; that’s why advertising agencies had a total revenue of $35.3 billion dollars in 2011 — the rich have to get us into their stores to buy their beer and shampoo.[1]

The problem is, though, that the bulk of the one-percenters’ wealth is no longer coming from investments, but rather through executive compensation packages. As a Citicorp document from 2005 asserted approvingly, “the resurgence in [the fortunes of the top 0.1%] since the mid-eighties [is] mostly from oversized salaries. The rich in the U.S. went from coupon-clipping, dividend-receiving rentiers to a Managerial Aristocracy indulged by their shareholders.”[2] At the same time, real wages for all quintiles have been declining since 1999; however, the decline has been worse for those in the bottom quintiles than for the top.[3]

And while investment assets have been concentrating in the top 10% (88%), the debt has been concentrating in the lower 90% (72.5%).[4] Every dollar spent on debt, on interest and demand already satisfied, is a dollar that can’t be spent on current demand or invested for one’s future. The overall picture is of a lower and middle class whose disposable income is shrinking and over-leveraged, diminishing their capability to consume and invest.

So here’s the dilemma: On the one hand, we have to have a wage structure that recognizes differences of task complexity, training, experience and responsibility, as well as providing incentives and rewards for further training, hard work and top performance. On the other hand, employees are consumers, and it’s in the best interests of business owners and shareholders to have as wide a customer base as possible. As I’ve said before, you can’t get out of consumers’ pockets what you’re not putting into your employee’s pockets. So we need a pyramidal compensation structure … but the structure needs to be flatter than it currently is, with more money getting to the bottom of the pile.

This is not a call for government redistribution. Indeed, the best way to fend off the government’s ham-handed attempts to redress the problem is for owners and stockholders to restructure their compensation structures themselves. Profit-sharing, employee stock warrants and employee ownership should be considered as methods which, in accounting terms, don’t increase wage and salary expense but which accomplish the same thing as wage and salary increases.

This, then, is the practical problem with income inequality: concentrating wealth at the top takes money out of circulation and saps consumption of goods and services. The US has the Gini coefficient of a second- or third-world nation; even after taxes and transfers, it’s one of the five worst in the OECD.[5] The longer this progresses, the more likely it is we’ll eventually have the economy of a second- or third-world nation.

If we don’t already.


[1] Census Bureau, Annual Services Survey, 2012.
[2] Kapur, A.; Macleod, N. and Singh, N. (2005, October 16). Plutonomy: Buying Luxury, Explaining Global Imbalances. Citigroup Global Markets Industry Note; p. 5.
[3] Census Bureau, Current Population Survey, Annual Social and Economic Supplements, 2013.
[4] Wolff, E. N. (2012). The Asset Price Meltdown and the Wealth of the Middle Class. New York: New York University. Cited in Domhoff, G. W. (2013, February). Wealth, Income and Power. Retrieved January 3, 2014 from University of California-Santa Cruz: http://www2.ucsc.edu/whorulesamerica/power/wealth.html.
[5] See Wikipedia, “List of countries by income inequality”, which references data from the UN Development Programme, the CIA’s The World Factbook, and the Global Peace Index: http://en.wikipedia.org/wiki/List_of_countries_by_income_equality.