Thursday, August 11, 2016

Income Inequality is Not a Problem

The problem with identifying “income inequality” as a social problem is that it misses all the real problems and it implicates non-problems as problems. The desire to alleviate poverty is legitimate, but the blaming of rich people isn’t.

Some people have a hard time in life, for a variety of reasons. Some people have serious emotional issues that make them difficult to employ. Some people have serious absentee/tardiness issues, or just general conscientiousness problems, that make them unreliable as employees. Some people, for whatever reason, failed to acquire any kind of relevant education (college or vocational) and thus have no useful job skills. Some people have a relevant education, but for whatever reason refuse to work at a meaningfully remunerative job (I have seen so much of this, and it is almost always baffling to me). Some people are government workers in cozy jobs whose cost-of-living-adjustment suddenly stops because the government goes broke. All of this is merely to observe and explain, not to blame. Sometimes it really *is* the person’s fault, and sometimes it isn’t. Either way, it’s wrong-headed to tell these people, “You’d be doing a lot better if these rich people weren’t hoarding society’s resources!” Or “If only the political system weren’t dominated by rich interests, it would work better for you, and you’d be sharing more of the wealth.” That’s not what these people need to hear. This kind of scapegoating is shameless pandering when a politician does it and self-congratulating escapism when the “underpaid” workers themselves do it. Either way it’s grossly irresponsible. There are usually actions the person can take to improve their circumstances, and we should encourage that. We shouldn’t be telling them, in effect, “Your problem is due to someone else’s greed, and only a massive change in government policy will fix it.” Without casting any moral judgment, I want to point out the causal mechanism proposed within the income inequality framing is simply mistaken. It just isn’t true that the rich are richer *because* the poor are poorer.

If you aren’t careful, it’s easy to take on a zero-sum worldview (inadvertently or explicitly). It’s easy to think “If he had less, we’d all have more.” Or “Society’s income is $16 trillion per year. We just need to dole it out more equitably.” We don’t live in a zero-sum world. “Society’s income” isn’t something that belongs to all of us; it’s not something that is wrongly and arbitrarily doled out unequally to make a few random winners rich. There really are people whose annual productivity is in the millions of dollars. If large companies didn’t shell out to place the most talented possible individual in their executive roles, they could lose out on millions or even billions of dollars. And without an appropriate incentive to perform, that talented executive might make avoidable million dollar errors. It’s easily possible that the *very* best person for the job of, say, running Microsoft will contribute $10 million more a year to the expected bottom line than the second best person. Getting that person for $5 million would be a steal for the shareholders and for the software users who are using the improved product and the employees of Microsoft who are made more productive by the CEO’s actions. Getting that very best person to put in their very best effort could easily be worth another $10 million. If the difference between a motivated and an unmotivated executive is $10 million to the company’s bottom line, then a generous bonus in the millions of dollars is economically justified. Perhaps the very best executive has a 1% chance of totally destroying the value of a large company over their tenure (say Microsoft, with a market cap of $450 billion), but the second best has a 2% chance of totally destroying the company. This consideration alone makes that top executive worth ([2%-1%] * $450 B = )  $4.5 billion. If Microsoft can acquire this person by making them a billionaire once or twice or even thrice over, it’s worth it. Sorry to burst anyone’s populist bubble, but those very large executive compensation packages make economic sense. You’re *richer* because of them, not poorer. I think it’s not hard to understand that an executive’s productivity should scale up with the total value of the company, and that their take-home pay should reflect this productivity. People react with outrage to these big compensation packages, but economically speaking they are justified.

Consider now a more modest form of inequality: those salary differentials between the professions. These are a feature, not a bug. They are a market signal directing people to where work is most dearly needed. Very high salaries for doctors, lawyers and actuaries are signals that “The world needs one more doctor/lawyer/actuary more than it needs one more teacher/secretary/cashier.” If the pay differential were too small, you wouldn’t have enough people who are willing to undergo the long years of training necessary to enter these professions, and you wouldn’t find enough people to do the often thankless, boring, or even dirty tasks that these jobs entail (and while working longer hours than an average worker).  More to the point, people aren’t being assigned these professions at birth; they choose their profession *knowing* that these salary differentials exist. It’s extremely churlish to choose a low-paying profession while complaining that a higher-paying profession earns more. People don’t just fall into these positions. They end up there after having followed a long and arduous path. Your current profession is a sum of many past choices and your past effort. 

Some people make the mistake of interpreting salary differentials in terms of value judgments, as in “Isn’t education just as important as medicine?” It’s the wrong question, and answering it doesn’t tell you anything useful about how much doctors should be paid vs how much educators should be paid. The actual question is more like, “What is the social value of *one additional doctor* vs *one additional teacher*?” And more to the point, “What salary will attract the extra doctor we need, and what salary will attract the extra teacher we need?” It’s not as though there are a fixed number of slots to fill, and we can just fill them all with any arbitrarily chosen salary figures. The actual number of people willing to enter the profession changes, moves up and down, in response to the salaries offered, and in turn those salaries adjust up or down with the number of people willing to enter the profession. (This is the standard intersecting-supply-and-demand-curves stuff from econ 101.) Inserting your own moralistic value judgment into this consideration would be arbitrary and wouldn’t help you answer the question “What *should* these relative salaries be?”

I have no doubt that there are some people who make an undeserved fortune by adjusting the rules to favor themselves. Perhaps an auto producer or textile company profits from an import quota or tariff. Or perhaps a mega-farm gets paid by the government to leave thousands of useful acres of farmland fallow. Or onerous regulations make it hard for small start-ups to challenge incumbents. It’s often the case that the companies benefiting from these market restrictions are the same companies that actively lobbied for those policies. These gains are ill-gotten. But it’s the “ill-gotten” part that’s the problem, *not* the “gains” part. By fixating wrongly on inequality, we would falsely impugn the honest business owners who earn their fortunes honorably through voluntary transactions. And we might wrongly overlook these kinds of ill-gotten gains if the thief fails to enrich himself compared to his competitors. In both cases, “inequality” is a terrible proxy for the real problem. For both kinds of errors, the inequality framing *completely misses* the problem. 

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