Income Inequality is a Fact of Reality

In a recent email from the Politix website there was asked the question of whether income inequality concerned me. The first paragraph of this post was my answer, which I expand on.

In and of itself, income inequality is not a problem and is simply a fact of reality. Everyone has different levels of skills, different interests, different levels of ambition to actually make a larger income and different things are more or less in demand than others – to name just a few factors that can go into a difference in income. Thus it is entirely possible, and appropriate, that someone who is highly skilled in an area that others find valuable (i.e., it is in high demand) and is willing to work hard will make more money, often vastly more money, than someone who is lazy and not very skilled in an area that no one else finds of value. Most Americans understand this on some level and do not begrudge the fact that a person who has created a great product that everyone loves makes a fortune. It is the very fact that people can and do make their fortunes in this way that has driven progress for hundreds of years and will continue to do so.

An area where the above does not appear to be true and where some might see a problem is when one cannot conceive of the productive purpose a particular job serves or of the skills required to perform it. Most Americans have played baseball at one time or another and so they have some idea about what purpose a great hitter or pitcher serves for a team and the skills needed to reach the major leagues and so most have few problems with the salaries for the top ballplayers. On the other hand, CEOs and bankers perform tasks that very few people understand let alone have any idea of the actual skills required to do them.

For example, most people do not understand that in a free market, bankers and others in the financial markets serve two main functions; pooling resources to pursue projects that could not otherwise be undertaken, and allocating these resources to the areas where they can most profitably be employed. If it will cost $1 billion to create a new automobile manufacturing plant and no one person has the money and/or wants to create it, the bankers will bring together the resources of a large number of people, who likely have no interest in building a car factor buy simply want a decent return on their money, to accomplish it. The second skill involves developing the ability to judge which projects will succeed and investing in those while avoiding those that will not. Those who fail in doing this will soon be out of business either from their own losses or from the fact that people will soon stop giving them money to invest. This ability to pool resources and allocated them to where they can be most productive is the basis for the often large incomes of those in the financial markets enjoy while at the same time increasing the wealth of the entire country. Once you understand the work and skill required to achieve this, and the benefits that come from it, concerns that those who are able to do it make more money disappear just as in the case of professional ball players.

Where income inequality is a problem is when the income generated does not come from skill and hard work, whether the skill involved is actually understood or not, but rather at the expense of others, from playing the system. Outside of criminal activity, which everyone condemns, this situation is most often seen when the government, with its monopoly on the use of force, involves itself directly in the economy. We saw this most recently with the government response to the financial sector during the recent recession. Prior to the recession, some bankers, often responding to perverse incentives established by the government, made bad choices about where to allocate the funds they controlled,  e.g. the housing market, and when those investments faltered the banks were on the verge of collapse. The government stepped in and protected the banks from the consequences of their bad investment, resulting in many situations where those who made bad choices still made large salaries and profits, not because of their productive ability but because the government took money from others to give to them.  (It is worth noting that this “too big to fail” principle is now explicitly part of the law rather than being merely implicit. As much as some in government, and the public, rail about businesses privatizing profits and socializing costs, they have legalized exactly that in the financial sector, at least if you are one of the banks deemed too big to fail.)

In claiming that income inequality is by its very nature bad, those on the left ignore the fundamental differences described above. Americans rightly condemn those who gain their money from “playing the system” rather than productive ability. They do not, however, see the fact that those who are skilled, creative and hard working make far more money than those who are not as a problem, but rather see it as motivation to encourage themselves and others to work hard and achieve the same level of wealth. This used to be called pursuing the American Dream. In penalizing the wealthy, which is what all the “cures” for income inequality attempt to do, regardless of how the wealth was created, they undercut the ability of anyone to achieve this dream, if not outright preventing its achievement.

If you truly believe that income inequality is a problem, work to eliminate the primary factor that make it objectionable – government intervention in the economy.

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