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Free Market Society: Inequality and politics

The American journalist H.L. Mencken once wrote, ‘There is always a well-known solution to every human problem – neat, plausible, and wrong’. I would have to agree with him, but I’ll also have to take it one step further. It isn’t just the simple solutions people get wrong, but often the problem itself.

The older I get the less ideological I become, not because I think my ideology is inherently wrong, but because ideology encourages simplistic thinking.

The issue of income inequality

I’ve discovered, over the decades, it’s rarely as simple as we assume. Problems are often more complex than ideologues would like to admit and so are solutions.

Consider the issue of income inequality. Great inequality in wealth can stifle an economy. But, also think of individual cases of inequality.

A small town on a highway is pretty much equally poor. One individual in town decides to set up a cart and sell food to those driving by. People stop and discover they like his food. They pay for his food and he gets richer, even if the rest of the town doesn’t.

He isn’t stifling the economy. For all practical purposes, he is the economy. Over time, his food stand becomes a kiosk, then his kiosk becomes a restaurant. He hires assistants to help him and, over time, he becomes the richest man in the village. But, other people, those he employs, also become better off. Others start to develop businesses because of the influx of customers stopping to eat, and they too become wealthier.

Over time, a village that was once miserably, but equally poor, becomes unequally well off. Inequality increased but everyone is better off. Is that a bad thing?

These sorts of experiences seem to contradict the studies arguing inequality is bad for economic development. But maybe it isn’t wealth inequality per se that’s the problem, but how inequality comes into existence.

Equal misery at the bottom

Certainly in the old communist system of the Soviet Union there were people who lived very well off while most people were quite miserable.

The various commissars and bureaucrats who centrally planned the economy, planned it so they lived in relative luxury while the much praised ‘workers’ were often hungry, lived six to a one-bedroom apartment, and stood in lines for hours for a loaf of bread.

The central planners did well for themselves but produced nothing. Their entire profession prevented the masses from accumulating wealth so that there was widespread equal misery at the bottom, while the political elite lived very well off.

Wealth inequality reduces economic prosperity

A paper, Does Wealth Inequality Matter for Growth?, was written for the German Institute for the Study of Labour by two researchers, Sutirtha Bagchi and Jan Svejnar, who confirmed wealth inequality tends to reduce economic prosperity, but only under specific circumstances.

They noticed the studies this conclusion was based upon did “not adequately account for the sources of inequality. Consider Indonesia and the United Kingdom. Although these countries appear similar on measures of income inequality… they differ markedly on such dimensions as the role that political connections have played in achieving economic success and bringing about their distribution of income and wealth. Yet, virtually all empirical studies ignore this distinction and examine the effects of aggregate measures of inequality on economic growth.

Structural inequality versus market inequality

William Easterly noted this as well, writing there is often confusion between ‘structural inequality and market inequality’.

In markets there is inequality of wealth because there is inequality of production. Some people produce more than other people. Not all labour is equally valuable.

Structural inequality relies on politics. The state may put roadblocks in front of some people in order to benefit others. This sort of economic inequality relies more on political pull than on productivity.

The recent rise in inequality in China is clearly market-based, while high inequality in Brazil or South Africa is just as clearly structural. Only structural inequality is unambiguously bad for subsequent development in theory; market inequality has ambiguous effects, it could have some of the adverse effects cited in the above models, but eliminating it would obviously have negative incentive effects.

– William Easterly, American economist

One can become wealthy because one is productive, or because one is politically connected. Some people are paid very well to run private companies because their efforts make the company more productive and improve life of the workers and the consumers.

But one can also be paid very well because of political connections. One may be appointed head of a state-owned enterprise, not because of innate business talent, but because they are a buddy to a politician or a former mistress.

These individuals tend not to be talented or productive, and the more control of economic resources they have, the worse off the country.

In conclusion

The apparent conclusion from the evidence is wealth inequality per se is not so much the problem as how inequality is created.

When the political process stifles competition, it not only drives up prices for consumers but also drives up profits for the politically connected owners of the favoured companies. That is quite different from those whose wealth is created by satisfying consumer needs.

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