Income Inequality: Is It Really a Problem?
It is not uncommon for politicians and pundits, particularly those of the liberal persuasion, to deplore income inequality. Clearly, income inequality exists. For example, the income of a brain surgeon is considerably higher than that of a cashier. But is that a problem? The fact that a significant portion of the population believe income inequality to be a problem, even if due to the envy of the wealthy stoked by those engaged in class warfare demagoguery, makes the notion of income inequality worth discussing.
I have yet to hear any of those who publicly lament income inequality state precisely why they consider income inequality to be a problem. We are left with the impression that they feel that it is somehow unfair that the very rich have a lot more money than average working people.
There seems to be a tendency on the part of some to conflate equality of opportunity, which most people support, with equality of end result. Now, given that people have very different talents and abilities and life situations in general, it is possible to have either equality of opportunity or equality of end result (or neither), but you can’t have both — with one exception, namely, forced equality of end result with no opportunity for advancement. The latter could be accomplished, for example, by instituting a guaranteed annual income set equal to the minimum wage, coupled with a 100% tax on all income above that amount as well as a 100% tax on inheritance. Such a policy of enforced equality of end result would stifle innovation and put us on a downward path to stagnation.
Our society is in the thrall of this very seductive but ultimately destructive meme of entitlement, dating back to the New Deal and transmitted intergenerationally by cultural indoctrination. We hear advocates of raising the minimum wage asserting that the minimum wage should be a living wage, apparently subscribing to the Marxist (“from each according to his ability, to each according to his needs”) idea that resources should be allocated based on need, rather than the capitalist principle that workers’ wages should be determined by the free market value of their labor. Some assert that everyone should be entitled to an education and healthcare, regardless of their ability to pay for these services.
Let’s consider the logical implications of the entitlement claims mentioned above. If everyone is entitled to a living wage, education, and healthcare, that implies that some entity, presumably the government, has a duty to provide these things. If the government were to mandate raising the minimum wage to a so-called living wage, while that would not result in any direct cost to the taxpayers, there would be a number of other associated costs, as described in my article Solving the Unemployment Problem. If the government were to provide education and healthcare to those who couldn’t otherwise afford these services, the cost of doing so would have to be borne by the taxpayers. Thus, those who make such claims of entitlement are, by implication, asserting that they are entitled to the fruits of other people’s labor.
Some have pointed to the increase in income disparity over time, using as a metric, for example, the ratio of the pay of the CEO to that of the lowest-paid worker in that company. To assess the cause of this increasing income disparity, it would be useful to have some historical perspective.
During the Renaissance, prior to the Industrial Revolution, the economies in villages throughout Europe closely approximated the ideal free market. The income of the workers producing the various goods was determined by the amount that they could sell, which was, in turn, limited by the amount that they could produce. Given that artisans had only hand tools to work with, the productivity and hence the income of a highly skilled artisan could not greatly exceed the income of a merely competent artisan in the same craft. The income of workers in a service trade such as barbers was limited by the number of clients that they could serve. The result was that there was no great income disparity among the workers.
With the advent of the Industrial Revolution, two innovations dramatically affected the relationship between workers, productivity, and income, namely, machines and hierarchical organizations. Although these innovations operated together, mainly in factories, it would aid in the understanding of their effects if we considered them separately.
Suppose that prior to the Industrial Revolution, a weaver invented a weaving machine that could increase his productivity tenfold over what was possible with a handloom. If we assume that there were many weavers in the village, so that the weaver with the weaving machine had a relatively small share of the market, that the weaver would be able to increase the number of garments that he sold and hence his income tenfold.
Now, suppose that all of the weavers in the village were able to acquire weaving machines to replace their handlooms and were thus able to increase their productivity tenfold. Would their incomes likewise experience a tenfold increase? No, because the increased supply of textile products would cause their price to drop. Since the demand for textile goods is presumably elastic, the reduced price would cause more of them to be purchased. The result would be that while the weavers would experience some increase in their income, it would be less than a tenfold increase. The villagers as a whole would benefit by virtue of the reduced price of clothes, blankets, and other woven goods.
The advent of factories complicated the definition of worker productivity. If the factory consists of each worker producing a product such as a garment from start to finish, then it is possible to measure and compare the productivity of the workers by the number of garments that they produce. However, in a factory such as one manufacturing automobiles, where each worker on the assembly line is responsible for a different part of the process, it becomes problematic to assess and compare the productivity of workers performing these different functions, which, in turn, complicates the problem of determining the appropriate wages for the various types of jobs.
Fortunately, there is a simple way of setting the appropriate wages for workers who perform part of the process of producing the finished product, namely, the free market. The employer could begin by setting the wages equal to the prevailing wages for the particular jobs. Over time, he could adjust the wages so that he is able to hire and maintain a sufficient number of workers to perform the needed jobs.
Some have pointed to the fact that in recent years, while average wages, after correcting for inflation, have remained flat, the productivity of the economy has increased, implying that the workers have not received their fair share of this increased productivity. Assuming that the premise is true (I have no reason to believe otherwise), the conclusion regarding the unfair treatment of workers doesn’t necessarily follow. First, as illustrated with the example of the weavers above, only part of the benefit of increased productivity goes to the producers; the rest of the benefit is diffused among society as a whole via lower prices for the produced goods and services. A prime example of this is the reduced cost and increasing power of computers over time. Thus, while wages have remained flat, the standard of living of workers has increased due to the lower prices of some goods and services.
A second reason why wages have remained stagnant is foreign competition. In order to stay competitive with foreign imports, companies have been forced to outsource and locate offshore where possible, as well as resist pressure to increase their workers’ wages. Workers as consumers have benefited from the lower cost of imported goods. Since most of the countries with which we trade have lower wages than our country has for equivalent work, abolishing the minimum wage would allow wages to fall to the point where we would no longer be at a competitive disadvantage due to our higher labor costs. Those who are opposed to abolishing the minimum wage have a case of what might be termed economic agoraphobia — fear of the open market.
A third factor to consider is that while wages have remained flat, labor costs have increased due to government mandates. These include the Social Security tax, part of which is paid by the employer; unemployment insurance; workers’ compensation; complying with the Americans with Disabilities Act; and providing health insurance to employees as required by the Affordable Care Act.
A fourth consideration is that while average wages may have remained constant over time, most workers enter an organization at an entry-level position and move up the organizational hierarchy to increasingly lucrative jobs as they gain skills and experience so that their wages increase over time.
Like machines, hierarchical organization can be a productivity multiplier. To illustrate, an independent real estate agent, no matter how successful, is limited in the number of clients that he (or she) can serve in a day due to the time required to serve each client; that limitation, in turn, puts an upper bound on his possible income. Now, suppose that the real estate agent opens an office and hires ten real estate agents to work for him. He could then receive part of the commission of each of his employees and thus increase his income. To further increase his income, he could establish a company and franchise real estate offices around the country and receives a franchise fee from each of the offices.
Those at the top of a hierarchical organization benefit most from the latter; the larger the organization, the greater the benefit. This accounts for why the ratio of the pay of the CEO to that of the lowest-paid worker in that company has increased over time, namely, because the size of corporations has increased over time. Another possible factor is an overly cozy relationship between the CEO and the board of directors who set the compensation for that CEO. This latter issue could be addressed by the shareholders demanding greater transparency in the process of determining the pay of the CEO.
While technology has been a net benefit to society, some have benefited more than others. To see an example of this, we can categorize service providers based on whether or not their service requires a two-way interaction with those whom they serve.
Service providers that require interaction with their clients include doctors, nurses, teachers, barbers, and merchants. Modern technology has resulted in at best a modest increase in the number of clients that these service providers can serve per day.
Entertainers, including actors, singers, musicians, comedians, and professional athletes, don’t require a two-way interaction with their audience/viewers. Prior to the Industrial Revolution, the size of their audience was limited to those who could see and hear their performance unaided by technology. With the advent of radio, television, and the internet, the number of people who can simultaneously hear and view their performance and hence the performers’ incomes, has increased by orders of magnitude.
Finally, let’s address the arguments of those who claim that women are not being paid equally with men for the same work. They cite statistics showing that the average wage of women is significantly less than that of men, implying that women are being unfairly treated and want the government to step in and mandate equal pay for equal work. However, this discrepancy in average wages can be explained by a number of factors; no need to invoke the heavy hand of government to correct what is merely a problem of misperception.
Historically, the educational level of women has been considerably less than that of men. Although this educational gap has largely disappeared in recent years, it will take some time for women entering the workforce to work their way up the organizational hierarchies into better-paying jobs.
A second factor is that men tend to remain in the workforce longer than women. This is due to the fact that women who have children often drop out of the workforce to take care of them. Men, by contrast, rarely leave their job to care for their children; if anything, they may take a second job in order to support their growing family. Since income generally increases with time in the job, this factor alone can account for much of the wage gap.
A third factor that can contribute to this wage discrepancy is that women disproportionally tend to gravitate to jobs such as teaching and nursing that involve a two-way interaction with those whom they serve, perhaps because women are, on average, more empathetic than men. For the reasons discussed above, these jobs tend to pay low or at best modest wages.
If we compare men and women in the same occupation having equal education and job experience, most of the wage discrepancy disappears. To account for the remaining wage gap, consider the following example. Suppose an employer has two candidates for a job, a man and a woman. Assume that they have equal education and previous job experience. Under these conditions, the man would be the more desirable employee. Here’s why. The woman is more likely to drop out of the workforce sooner than the man to take care of her children. Since hiring and training a new employee to replace an existing one is a significant expense, hiring the woman is likely to be more costly to the organization than hiring the man. Even if the woman doesn’t leave the job as a result of having children, she is likely to require maternity leave, which can be disruptive to the organization; men rarely take paternity leave, and when they do, it is usually of shorter duration than maternity leave. If the woman returns to the job after having children, she is more likely to take sick leave to take care of a sick child than her male counterpart. To compensate for the expected added cost associated with having a woman employee, it makes sense for the employer to offer her a lower wage than the man. An alternative would be for her to prove that she is incapable of having children, or for her to sign a contract agreeing not to have any children for, say, five years, with a financial penalty provided if she violates that agreement.