Income inequality, overvalued metric ?

Election after election, cycle after cycle, candidates and celebrities use the same talking points on income inequality: “Inequality is the root of all evil,” said Pope Francis. “Income inequality is the defining challenge of our time,” former President Barack Obama said. “We need economic policies to tackle grotesque inequality,” said U.K. Labour Party Leader Jeremy Corbyn.

According to some, the marriage between democracy and capitalism is destined to end in tatters, given the crippling income inequality produced by free trade and a regulation-free market. The top 1 percent has 50 percent of the wealth, and the freer the market, the wider the gap between rich and poor.

The problem with this reasoning, however, is that it lacks a historical contextualization. 

Ever since humans evolved from hunter-gatherers to settlers, inequality has been the norm, and social mobility nonexistent. Before the industrial revolution, no country had what is now called a “middle class” or a prominent mercantile one. There was the top 0.1 percent (nobility and religious institutions) holding 99.9 percent of all wealth that was created by the rest of the population, who subsisted off the land in poverty and despair.

This changed with the industrial revolution and the introduction of free markets. Extreme poverty went from affecting 85 percent of the world’s population in 1800 to less than 10 percent today. If this trend continues, we can hope to see extreme poverty eradicated by 2030. Global per capita GDP exploded from less than $1,000 to more than $10,000 since the invention of the steam engine in 1775. As the pie has gotten bigger, so has everyone’s slices.

This trend is in not slowing. In 1971, the average worker in the U.S. had to work one month to afford a television. Today, thanks to capitalism and innovation, it take two days. In 1971, only 50 percent of girls completed primary education. Today, it is more than 90 percent.

The fastest declines in poverty are now happening in countries joining the global trading system and embodying free economies (India, China, or Colombia), whereas protectionist governments (Venezuela or Pakistan) seem to doom their populations to destitution.

Given these once-unimaginable economic surges, what are we to make of those who say the rich should be taxed more, that social mobility is on the wane, and that redistribution of wealth is the way to go?

Would taxing the rich really close the income gap between rich and poor? A study from the Brookings Institution suggests quite the opposite. If the tax rates on the wealthiest were raised from 39.6 percent to 50 percent, (without mentioning the instantaneous affect of incentive) and the $96 billion in additional revenue was redistributed to the poorest households, they would only see about $2,650 per household. The authors conclude that this approach is, at best, vastly insufficient in tackling the broader challenge. 

According to Brookings, the way to solve poverty in the U.S. is a simple 3-step process, that if followed will significantly increase an individual’s chances of joining the middle class:

1. Don’t have babies out of wedlock.
2. Hold a job.
3. Graduate from high school.

Follow these simple guidelines and chances are you're on your way to the middle class. 

Studies also show that those who begin in the bottom income quintile move up to a higher quintile within 10 years. Another study found that 43 percent of families in the poorest income bracket and 27 percent of those in the second poorest saw earnings grow at least 25 percent over a two-year period. (Today, roughly 56 percent of those in the top income quintile can also expect to drop out of it within 20 years). Social mobility, up or down, despite being lower than we may like, is undeniably still significant.

So much for individuals, but social mobility is even more noticeable across multiple generations. Today, one out of every five children born to parents in the bottom quintile will reach one of the top two quintiles in adulthood. Most children will earn more than their parents. 

Of course, capitalism has its flaws, and we should not be satisfied with these results. Income inequality is undesirable and social mobility should be even higher. But if history is a reliable guide, we seemed to have touched upon a good formula for success when we decided to form economies based on voluntary trades and personal incentives.

Income inequality is likewise not considered a reliable metric in determining the state of a country’s economy, or its general prosperity: Sudan has crippling poverty, but roughly no income inequality, whereas the United States has virtually no absolute poverty but has quite noticeable income inequality. 

China has seen rising income inequality (per its Gini coefficient) from 1980-2014, yet this has gone hand in hand with huge poverty reduction as the country has moved to a market economy. In contrast, Britain saw a modest fall of inequality after the economic crash of 2008. Would anyone dare to argue that Britain was better off due to a drop in income inequality? This metric might not be as valuable as we are told.

Here lies the true magic of capitalism, or more precisely, free trade: it essentially turns self-interest into group-interest; by rendering the pursuit of self-interest dependable on the interest of others. If one desires wealth, others have to voluntarily engage in monetary transactions with him. He has to effectively better the lives of his fellow man in order to better his own.

Most of capitalism’s critics say it is dependent on self-service and greed. But what man-made system is not? Were socialism or communism the embodiments of charity and moral superiority? Or was the power, instead of being potentially in hands of all, clutched within the immovable hands of the state?

Greed is in our DNA, it’s as human as our survival instinct. Most, if not all, of the great advancements of our history have “come about individuals pursuing their own interest” says Milton Friedman, Nobel prize winning economist:

“Henry Ford’s invention of the automobile or Einstein’s theory of relativity have not come about by direction of a bureaucrat, or as a result of a government program, but as the result of individuals pursuing their separate interests.” 

If we wish to truly fight poverty and improve the lives of the impoverished, it is by liberalizing markets even more and incentivizing people to innovate, and by reinstating competition as the norm. It is not by crippling small businesses with government regulations and killing incentives to earn money or plan an inheritance for one’s children. It is also by delivering decent education, which provides people with skills for decent jobs and decent incomes, but not by forcefully applying a bureaucratic vision of what the fittest way to distribute wealth is. Students of history know where such state-led communitarian decisions usually lead.