In the last decade or two, inequality has become the left’s new buzzword, since it’s kind of awkward how well economic freedom has done at reducing poverty and hunger. It is a blunt analytical tool, however.
In the stultified class warfare rhetoric of the left, all socio-economic problems are caused by the rich, or by capitalists, or by employers, or by landlords, or by multinational corporations. The crude solution to all these problems, they say, is to tax the rich ‘because nobody needs a billion dollars’ or tax ‘windfall profits’, and then to redistribute this bounty to the poor by means of social services or cash payments.
The left faces a problem, however. Every single example of a society in which the state owned or directed the means of production, and has attempted to extract ‘from everyone according to their means’, and provide ‘to everyone according to their ability’, has ended up as a catastrophic failure, leading to poverty, famine, pollution, poor health and shorter lives.
By contrast, societies in which individuals, or voluntary associations of individuals such as companies, are free to decide where to invest their capital, what products or services to produce and sell, and what prices to charge, always outperform their less free counterparts, on every measure of human welfare, including the absolute living standards of the poor, nutrition, median prosperity, happiness, gender and racial equality, health and safety, and environmental standards.
In particular, and despite a recent uptick caused by brutal lockdowns, free market capitalism has resulted in a dramatic decline in world poverty rates everywhere except in Africa, where corrupt and authoritarian governments stubbornly cling to Cold War communist dogma.
This leaves lefties in a quandary. They forever have to make excuses for historical examples of socialism, arguing that it wasn’t really socialism, or was done wrong, or was really state-capitalism, or was thwarted by counter-revolutionary corruption, or was scuppered by bourgeois capitalist economic warfare.
Being unable to point to rising poverty as a crisis of free market capitalism, they had to come up with a new bogeyman, and they found one in the apparently unfair notion of ‘inequality’.
Inequality is, of course, nothing more than the communist desire for enforced socio-economic equality dressed up in modern language.
As an analytical tool for diagnosing social ills and constructing policy interventions, however, it is extremely blunt. The only apparent remedy for inequality is, after all, to take from the rich to give to the poor, even though this runs counter to the real-world experiment that proves economic freedom trumps coercive state intervention.
It doesn’t even attempt to assess, for example, the absolute living conditions of the poor. The United States, for example, is fourth worst in a ranking of wealth inequality. The only countries with higher wealth inequality are Sweden, Russia and the Netherlands.
Yet in the US, the official poverty line is $35.28 per day. That’s almost R600 per day, or R13 000 per month which would put you in the top 25% of income earners in South Africa. Even the poor in the US are richer than most people in the developing world.
By contrast, countries with the lowest wealth inequality include a few rich countries, but also Myanmar, Slovakia, Eritrea, Ethiopia, Belarus, Turkmenistan and Iraq.
Are they objectively better to live in than countries with higher wealth inequality, such as Denmark, Germany, and indeed South Africa?
Income vs wealth
Income inequality isn’t the same as wealth inequality, although the two are often conflated. They often directly contradict each other. Sweden, Denmark and the Netherlands have very high wealth inequality, but very low income inequality.
Confounding our attempts at drawing any conclusions from income inequality figures, Slovenia, Belarus, Slovakia, Azerbaijan and Kazakhstan also have very low income inequality.
Ironically, successful free market economies tend to exhibit fairly low income inequality, while beacons of world socialism, like Venezuela, Zimbabwe and Mozambique rank high on the inequality list. If socialism reduces income inequality, it isn’t visible in the data.
Somewhere in the middle, we find the UK, Luxembourg, Ethiopia and Nigeria, back-to-back, with almost identical Gini coefficients of between 34.8 and 35.1. The Gambia and Italy both have a Gini coefficient of 35.9. Mongolia and Switzerland are level on 32.7. Japan and Mali are separated by a mere tenth, on 32.9 and 33.0, respectively.
What does this tell us about these economies, or about the plight of the poor in these countries? Absolutely nothing.
South Africa comes last in the world, with the highest income inequality, but that’s largely because it also has the world’s highest unemployment rate. If half your population earns nil, income inequality is going to be sky-high no matter what.
From a policy perspective, the solution to South Africa’s problems lies in vibrant economic growth that is high enough to attract investment and create employment. That requires free markets with sound institutions and minimal, light-touch regulation. An analysis based on inequality offers no policy suggestions to achieve growth. It merely advocates redistribution.
Within South Africa, too, income inequality is a poor measure. The Eastern Cape and Limpopo are South Africa’s poorest provinces, with the highest poverty rates and lowest GDP per capita. Yet the Eastern Cape is the most unequal province (alongside KwaZulu-Natal), and Limpopo is the least unequal.
What policy purpose does inequality have, then, if it does not predict any economic outcome whatsoever, aside from establishing a false metric designed to promote socialist redistribution?
Many years ago, I likened income inequality to a rubber band, anchored at zero. If all of society became 10% richer, inequality would increase, not decrease. Conversely, if a society is uniformly poor, it would have a very low inequality measure. Surely that cannot be preferable to a country where the poor are better off, but higher average prosperity means inequality is also higher?
Some economists believe that income inequality reduces growth in rich countries, but stimulates growth in poor countries. Other economists believe the exact opposite: that income inequality reduces growth in relatively poor countries but encourages growth in richer countries.
The contradiction likely results from the fact that economic growth itself always changes income inequality, and usually raises it, so trying to establish a causal effect in the other direction is a fool’s errand.
For the most part, inequality is an effect, and not a cause. It isn’t something you can change in order to achieve socio-economic objectives. It isn’t a policy lever. It is merely a coincidental feature of any economy that means very little.
A far more interesting result reveals the effect of wealth inequality on economic growth, finding that on aggregate, it reduces economic growth.
However, once the researchers controlled for how that wealth was accumulated, things changed: ‘We find that wealth inequality reduces economic growth, but when we control for the fact that some billionaires acquired wealth through political connections, the effect of politically connected wealth inequality is negative, while politically unconnected wealth inequality, income inequality, and initial poverty have no significant effect.’
Bill and Carlos
Consider one way of increasing both growth and income inequality.
Bill spends some time, material and effort creating software that millions of people end up using. His customers make him very rich by buying this software. Although every customer becomes a little better off because the software offers them subjective benefits, clearly Bill is going to be the big winner, and inequality will rise.
Is there anything wrong with that? Should we tax the living daylights out of Bill to punish him for coming up with such a popular product?
We know that taxes influence behaviour. You tax what you want less of, and subsidise what you want more of. So if you levy a wealth tax, you can be sure that Bill in future (and future Bills) will think twice before sinking their capital and time into producing something that benefits many customers.
Now consider Carlos, who through his political connections obtains a licence from the government to run his country’s only telecommunications network. He can charge what he likes for phone calls and data connections, since the government makes sure that Carlos has no competition. And he does, so his customers pay excessive amounts for basic communication services.
Carlos becomes just as rich as Bill, but his customers feel they’re paying more for it than it’s worth, only they have no alternative. Since Carlos got rich at the expense of his customers, who got poorer instead of richer, many will rightly feel that his exceptional wealth is ill-gotten.
These scenarios are not hypothetical. Bill Gates and Carlos Slim are real people. Similar instances of politically-connected exploitation repeat themselves around the world. They happen all the time in South Africa.
Whenever government requires businesses to be licensed, and especially when it restricts the number of licences in issue, it reduces competition. That raises prices, and ultimately makes customers poorer than they otherwise would have been, while making the licensed companies, and their shareholders, richer than they deserve.
Whenever a government gives preferential treatment to certain companies when awarding contracts, on grounds other than quality, price and the ability to deliver, it enriches these companies at the expense of others.
Whenever a government subsidises certain companies, or protects them by imposing import tariffs, it disadvantages actual or would-be competitors, which in turn leaves customers with less choice, lower quality and higher prices.
This is why politically-connected wealth creation has a negative impact on economic growth and the economy at large, while private wealth creation does not.
This is also why crude policies like taxing the rich – as left-wing advocates of the inequality metric propose – are counter-productive. They do reduce the ill-gotten wealth of politically-connected companies and individuals, but they also disincentivise private investment that raises growth, creates jobs and raises living standards.
The real solution is to reduce the amount of politically-connected wealth creation that is possible in an economy. The more innovation and industry happens in the private sector, free from patronage, corruption, over-regulation and political favours, the more the rising tide of economic activity can lift all boats.
Inequality is only a problem if government favouritism creates it. Without government interference, it is a meaningless metric bandied about by left-wing propagandists who either don’t understand basic economics or deliberately appeal to the base instinct of jealousy.