All Commentary
Tuesday, February 5, 2013

Reducing Income Inequality at the Expense of the Poor


Market economies motivate positive-sum activities in which people become rich by creating more wealth for others—both in the form of higher-paying jobs and improved goods and services at lower prices. That doesn’t mean everyone will earn the same, but it means improved conditions for everyone, even the least well off. It is far better, after all, to be poor in Cleveland than in Calcutta.
Yet when people talk about increasing income inequality, they almost always discuss the topic as a market failure calling for government correction. They invariably ignore the possibility that increased income inequality has resulted from things few people would want to “correct”—namely, individual freedom and the success of markets in satisfying the needs and wants of the masses.
Four such successes come to mind.
To begin with, the returns on education have increased significantly in recent years, as reflected in the increased salaries and wages that come with more education. This increased return is exactly what we should want as technological progress increases the productivity of those who acquire more knowledge and improve their abstract reasoning skills relative to those who do not. 
Second, profound social, economic, and political changes have combined to remove barriers to market access by women. Half the population now has full participation in a marketplace that had for generations been closed to them. More women than ever are taking advantage of the market's opportunities, often building on advanced degrees. Among those women, more are now majoring in fields that yield the highest returns. This choice goes a long way toward explaining why income inequality between men and women in the United States has declined in recent decades. In many fields—once factors such as differences in major, career selection, and duration of employment are controlled for—income disparities between the sexes evaporate. Despite this relatively equality between the genders, we should expect to find increasing income inequality among women as more women ascend to high-salary positions.
Third, the day has long passed in most countries when marriages were arranged without the consent of the betrothed. This freedom, along with the increased mobility people enjoy in wealthy countries, means that marriage markets in those countries are highly competitive, with each participant putting his or her looks, personalities, and prospects on offer to compete for someone who best satisfies what he or she is looking for in a partner. With more women getting advanced degrees and working alongside high-earning colleagues, marriage markets have generated more matches between individuals who each have high earning potential. 
Fourth, spurts of technological progress create big winners. But the resulting technological improvements leave everyone better off by making possible what has always been required for sustainable improvements in our general living standards: the production of more value with less effort and fewer resources—all while increasing the economically relevant resource base. 
For example, technological progress has recently made it possible for almost everyone in wealthy countries to enjoy the performances of the very best athletes, musicians, singers, talk-show hosts, comedians, etc., wherever they are, with visual and audio clarity that rivals and often exceeds that of live performances. Between those who entertain and those who bring the entertainment to our eyes at relatively low cost, we are bound to find high earners. In other words, technological access explains why people such as Tiger Woods, Britney Spears, and Oprah Winfrey have earned incomes that comparably skilled athletes and entertainers could not have imagined a few decades ago. Those entrepreneurs who develop ways to provide the most value to consumers at the lowest costs, such as Bill Gates, Mark Zuckerman, Michael Dell, and Jeff Bezos, also become billionaires at young ages. These achievements are consistent with other periods of rapid technological progress. One ambitious and intelligent individual, willing to take a big risk, can come up with the sorts of products and services that improve the lives of millions by offering them low-cost opportunities to be entertained, enlightened, and connected. 
It is difficult to imagine how anyone interested in improving the welfare of the least advantaged would want to lessen income inequality by reversing any of the four socioeconomic trends above. The increased prosperity these trends have made possible for the most successful among us is obvious. The increased prosperity and well-being for the poor is no less real, but these gains are commonly ignored in discussions of income inequality. 
Although creating more wealth is the most effective way of reducing poverty—and happens also to be a great way to become fabulously wealthy—one standard argument is that the poor would be better off if government reduced income inequality simply by transferring more money from the rich to the poor. 
The serious problem with this argument is that government transfers have never been very effective at reducing income inequality or improving the conditions of the poor. Ironically, most government transfers go to those who are not poor. The two largest federal transfer programs, Social Security and Medicare, are targeted to the elderly, most of whom are not poor (medical care for the poor is provided by Medicaid). Many seniors are poorer than they would otherwise be, though, because these programs reduce the incentives for people to save for their old age. These two transfer programs make up close to one-third of all federal spending, and there are many billions of other federal transfer dollars going to politically influential recipients who are not poor and are often quite wealthy (e.g., large agribusiness concerns, defense contractors, pharmaceutical giants, etc). 
Of course, some government transfer dollars and in-kind benefits do go to the poor, but they often perpetuate poverty among the most economically disadvantaged. When the poor make an effort to improve their skills and work hard to increase their incomes, the government money and benefits they receive are reduced by a large percentage of their additional earnings. Sometimes it’s more than 100 percent, leaving them with less take-home income than before. The result is that many poor people see little benefit in making the effort to earn more income, or any income at all. They are trapped in poverty by the very programs that were supposed to help them escape it. (We’ll pass over the army of administrators who skim a percentage of these transfers and enjoy lavish benefits.)
Relative economic freedom, despite the income inequality that results, has done far more to help the poor than government transfer programs have ever done. Indeed, government attempts to reduce income inequality would do little to reduce inequality but a great deal to hamper economic growth and reduce economic opportunities for the poor to improve their lives with productive effort.

  • Dwight R. Lee is the O’Neil Professor of Global Markets and Freedom in the Cox School of Business at Southern Methodist University.