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Inequality vs. Capitalism

Irwin M. Stelzer

At long last we are emerging from the blind alleys down which the debate about income inequality seems to have wandered. The first such dead end was marked “fairness.” The top tenth of one percent of earners feel the tax system unfairly expropriates too large a portion of their incomes, bloated though those after-tax incomes are with special tax advantages. Those in the top 1 percent who have not made it to the top 0.1 percent say it is unfair that they should have to charter jets while the 0.1 percent own their jets: Hillary Clinton, a jet-charterer, feels “broke” because jet-owning funders of her campaign are richer. Many members of the 99 percent believe it unfair that they should have to fly economy on vacation jaunts that they could not dreamed of taking a few short years ago. Developing countries believe it unfair that more productive economies claim “a disproportionate” share of the world’s resources. Politicians hope to cope with claimed unfairness by concocting measures of “happiness” to guide them.

The second blind alley is a street strewn with erroneous data, data that interfere with the formulation of intelligent policy. In this alley inequality is measured:

  • by comparing pre-tax incomes. Never mind that progressive income taxes sharply reduce inequality in incomes available for spending;
  • by incomes rather than by consumption, which is the real indicator of differences in living standards;
  • by ignoring the ameliorating effect on inequality of housing, food and other benefits.

The result of a trip down these dead-ends is an inability to recognize that widening inequality can co-exist with a massive increase in living standards at all incomes levels. The gap between the living standard of a Saks Fifth Avenue shopper and a Saks Fifth Avenue sales person is surely less today than it was a few decades ago, in part because of the expanded availability of health care, education, and a wider range of public goods. And in equal part because of rapid innovation. Consider only two. Inexpensive machine-made clothing homogenizes the appearance of all save the very poor as thanks to the tech-savvy prêt-à-porter artists who work their copying magic. Then there is affordable indoor plumbing. In the U.S. only 1 percent of homes had electricity and indoor plumbing in 1920; now, fewer than 1 percent do not. The gap in recorded incomes between rich and poor might be widening, but the gap in living standards is certainly narrowing.

The good news is that we are now emerging from these blind alleys, and proceeding to discuss what really matters in the real world of policy making. The first such issue is the effect of income distribution on slower than historically average economic growth. There is little doubt that lower earners are more likely to spend any incremental income than are the better off, their larders already over-brimming. So it seems obvious to left-leaning politicians that taxing the latter to increase transfer payments to the former will increase total consumption and therefore spur growth. Such a policy does create investment opportunities for the better off, but it also reduces their incentive to take risks and invest by reducing the after-tax return from investments. We simply do not know with confidence the net effect of such redistribution on economic growth. Which will add to the difficulties facing the newly elected congress next year when (if) it turns to the task of reforming the tax system.

The second bit of progress is that we are starting to include considerations of income distribution in policy debates that previously focused solely on economic growth. Whether or not inequality is rising, and no matter the reason, in this election season the voices claiming it is will overwhelm those citing data suggesting it is not, and studies by researchers pointing to the massive increase in social equality. Not a bad thing, since we need to consider the impact of various policies on their impacts on all income groups.

Consider first the zero-interest-rate policy of the Federal Reserve, which policy is driving up the price of houses by keeping mortgage rates low, and of shares, by forcing investors to move from low-risk bonds to higher-risk equities. The resultant wealth effect will, it is argued, spur consumption by wealthier families, stimulating growth the benefits of which will trickle down to the less rich. All at the expense of modest-income savers who have watched the returns on their savings shrivel. A high price for a growth steroid.

Then there is trade and immigration policy. Freer trade opens markets to America’s corporations and our financial sector, but at the same time exposes unskilled American workers to increased competition from low-paid Asian and Central American workers. Open immigration, which also keeps the wages of unskilled workers down and relieves Silicon Valley employers of the cost of training American programmers and such, has a similar effect: it is good if you have a large lawn, not so good if you are trying to make a living mowing lawns.

Finally, and perhaps most important, the perception of rising inequality, especially occurring as it does alongside the obvious fact that America no longer cares to or is incapable of asserting leadership in the world’s trouble spots, is calling into question the viability of Anglo-Saxon market capitalism. The days when Margaret Thatcher’s revival of the UK economy and Ronald Reagan’s “Morning in America” were models for emerging nations are long past. The economic success of China’s state-run capitalism is providing an alternative model, although revelations of corruption, huge income inequality as members of the ruling class profit from their political connections, and the parlous condition of state-owned enterprises (SOEs) and China’s banks is giving thoughtful proponents of the Chinese alternative to America’s system of regulated capitalism pause. Still, this generation’s “useful idiots” seem no less gullible than those who visited Stalin’s Russia, and include key American businessmen now quaking in their boots as China’s regulators storm their offices and take some into custody.

It would be a pity if, having emerged from the blind alleys down which the inequality debate wandered, we failed to defend the system that has produced more freedom and more wealth for more people than any other, demonstrating its ability to reform itself when necessary. Call it regulated capitalism if you prefer, but capitalism it remains.

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