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The Income Inequality Hoax

March 10, 2000

A pestilence stalks the land. It threatens to undo the current economic
expansion. It may undo any social good that has been accomplished this
past decade and may even result in blood in the streets.

What is this unspeakable horror, this evil genie that, if fully unleashed,
could mean the downfall of us all? What is this scourge that causes
increases in heart disease, cancer, depression, and even asthma, according
to the "experts?" According to some economists, this unfolding tragedy is...income equality.

Since income equality has never existed at any time in any society, on
the surface one seems hard-pressed to come up with an economically sound
reason for someone to use such apocalyptic language. As usual in this
business, there must be some other reason as to why so many journalists and
economists are beating the equality drums again.

Before going farther, we must define income inequality. Statisticians
like to divide people in this country into five categories, or quintiles,
according to income. They take the average and median incomes from each
quintile and then compare them with each other.

For example, the average income of the people in the bottom fifth might be
$12,000, and the average income of those in the next quintile $20,000. The
$8,000 is the income gap. Demographers claim that during the last 10
years, the average incomes of those in the top quintile have grown more
than the incomes of those in the lowest group. So even though absolute
incomes have grown in both groups, the fact that the income spread between
them has become greater becomes the cause for alarm.

The issue behind this differential is explained in this simple example.
Jones makes $10,000 a year, while Smith earns $20,000. Assuming no
inflation, a year later Jones is earning $15,000 and Smith makes $30,000.

It is clear that both Jones and Smith are better off than they had been
before, although in absolute terms Smith has earned a greater increase in
income than has Jones. According to the "inequality" economists, only
Smith is better off. In fact, according to their logic, Jones is actually
worse off after he has increased his income because the income spread
between Smith and him has grown. No matter that both men are better off. Economists have declared, instead, that inequality has become greater.

This may seem impressive to statisticians and welfare-minded politicians,
but, in truth, economists do not own the analytical tools that allow them
to declare the change in the "inequality gap" has made Jones relatively
worse off. To do so would involve what economists call interpersonal
utility comparisons. Economic analysis simply does not permit one to
perform such analysis, as Murray Rothbard pointed out in Man, Economy, and
State
. Therefore, even in its inception, this fetish regarding income
differences is bogus.

Nevertheless, we next need to explain how the arguments about inequality
are being presented. According to a recent U.S. News article, the news of
the alleged growing income gap is "deeply troubling." "The country's social
and political fabric could be damaged, some economists and others fear, if
the new wealthy are perceived as being more isolated, if resentment builds,
and if the have-nots increasingly shun the political system."

The writer, James Lardner, then goes to the heart of the matter,
declaring, "And there are more-pragmatic concerns: if too few Americans are
taking part in the boom, who is going to keep buying all that stuff at
Wal-Mart or Amazon.com? After all, consumer spending represents roughly
two thirds of the nation's economy." In other words, it all comes down to
aggregate demand. If "too much" income goes to the rich, they won't spend
it quickly enough or, worse, they may actually save their money (read that,
stuff it in their mattresses), and the fall in spending will ultimately
lead to recession.

But wait, there's more. Lardner declares that "a spirit of egalitarianism
was part of what set this nation apart in its early years." He appeals to
Alexis de Tocqueville's 1831 description of America as a place with a
"general equality of position among the people."

This last statement is
important, as Lardner unwittingly confuses the abolition of the rigid Old
World class structure with a non-existent abolishment of income
differentials between Americans. The former has been a staple of this
country since its beginnings, while the latter has never existed.

The "inequality" economists make their second mistake by appealing to
aggregate demand, demonstrating that a certain segment of this unfortunate
profession still has not progressed beyond Mandeville's Fable of the
Bees.
Fable was a 17th Century poem in which the author insisted that
what seemed to be private virtues (saving and investing) were really
harmful public vices. Three hundred years after Fable, John Maynard
Keynes took the same ideas out of poetry and tried to convert them to a
crude form of mathematics and logic. Mandeville, wrong as he was, actually
made more sense.

Without going into a lengthy explanation of Say's Law, suffice it to say
that one of the central themes of aggregate demand "theory" (we hesitate to
apply such an august word to this proposition) is that production and
consumption are two distinct and unrelated entities. There is a grain of
truth to this idea, as the mere production of something does not guarantee
its sale in the marketplace. However, as J.B. Say pointed out in 1803, the
ability to consume is directly derived from what one produces, as one's
income is dependent upon the productive services he or she provides the
rest of society.

The only way for such a condition to change even
marginally is for government to violently intervene into economic affairs,
and even those actions do not change the underlying truth of Say's Law. As
Rothbard has pointed out, consumption and production cannot be separated in
an economic system.

Throughout modern history, governments have attempted to spur "aggregate
demand" by creating and distributing new money in hopes that people will
quickly spend it. As Ludwig von Mises and Rothbard successfully noted,
artificial credit expansion by government is always inflationary and
distorts the economy's structure of production, ultimately leading to the
booms and busts of the business cycle.

Another government intervention scheme to promote income "equality" is the
progressive income tax. While in reality this is nothing more than a naked
attempt by the parasitical political classes to seize the wealth of
productive citizens, some economists promote progressive taxation as an
"automatic stabilizer." According to these economists, the government will
wisely spend the money that the taxpayer would have foolishly saved
(stuffed in his ever-present mattress).

In reality, the idea of calling
the confiscation of someone's paycheck to spend on political schemes
something that "stabilizes" the economy is terminology only politicians and
Keynesian economists could love.

Part of the damage Keynesians have inflicted upon economic thinking is
promotion of the mistaken belief that production simply occurs
automatically. There is no human element to an economy that is measured by
aggregates. Thus, if production cannot be linked to the actions of each
individual, then productivity has no relation to individual income. The
result, according to modern macro theorists, is that income is just
randomly distributed.

In fact, according to the Keynesians, capitalist economies not only
distributes income unfairly, but also over time the mechanics of capitalism
skew income toward the rich and away from others. In other words, to
paraphrase Lardner, the rich get richer and the poor get poorer. The only
thing that can keep such a tragedy from occurring is the wisdom of the
state.

When one examines economics from a praxeological or human action
viewpoint, however, a different picture emerges, as has been demonstrated
by the Austrian School of Economics for more than a century. Income is not
something that just randomly flows into an economy. It is the result of
individuals providing productive services that are purchased in a
marketplace.

The truth of this statement is self-evident. In the absence of coercion--the hallmark of a free market economy--income is either earned or given to
someone in form of charity or a gift. (The source of that charity or gift
is someone else's productivity.) An individual who earns income has
received it from someone else in exchange for a product or service that the
first person has provided.

Of course, even "inequality" economists recognize the relationship between
income and occupation. Thus, they insist that patterns established by
capitalism will push more and more people into menial, low-productivity
jobs while creating a class of highly productive and highly paid citizens.

It is the old Keynesian argument with a different twist. Economists Robert Frank and Philip Cook even have a published theory that
blames the personal computer for what they believe to be growing income
inequality. According to Frank and Cook, as firms can expand their
operations beyond their respective region because of the internet and other
forms of telecommunications, they increase competition. The new emphasis
upon technology, they say, "brings dramatically increased economic power to
an elite of managers, professionals, and deal makers." This action, they
say, increases market share for some and pushes others into poverty.

Some clear interpretation of their theory is in order here. What they are
saying is that advances in computer technology allow for information to
pass more quickly between sources and that some individuals are able to
sell their products and services to a wider market than before these
technologies came on line. Thus, by creating more competition, they
actually create monopoly. The less-competitive, more rigid structure is
replaced by a more competitive--and even more rigid--structure. These
last two thoughts do not fit together, but that is what these economists
are asking us to believe.

Again, we see the "fallacy of the bees." In reality, this new and more
productive economy has permitted low-skilled workers opportunities they
never had before. News reports of lawyers quitting their jobs to become
window washers or cocktail waitresses do not occur in a vacuum. As
productivity increases, demand for once-mundane jobs is growing.

Take the current wave of immigration into the United States. While there
are obvious problems that accompany such large migrations of people,few
will argue that the vast majority of these relatively unskilled workers
have found jobs and a decent standard of living in this country. If Frank
and Cook, along with the Keynesians, were correct, unskilled workers would
have no incentives to come here for jobs, as what jobs would be available
would be so low-paying as not to be attractive.

Finally, as Thomas Sowell has pointed out on many occasions, these
so-called income categories are not rigid. We do not have a fixed caste
system in this country, and a free market economy allows people to move up
and down the income ladder. According to Sowell, numerous studies have
pointed out that few people stay in one income category very long,
including poor people. In other words, the infamous "cycle of poverty" is
another myth propagated upon us by the political classes.

If there are dark economic clouds on the horizon, they have been placed
there by the state. Violent government intervention into peaceful exchange
and production can never result in production of more wealth. Instead,
government creates winners and losers and changes the system of incentives.
Where once people had to be inventive and creative in order to create
products that others wished to purchase, now they must pay off their
respective politician who will then attempt to change the structure of
property rights in order to transfer wealth from productive to
non-productive people. Read the Microsoft antitrust files for the latest
example of this outrage.

Then there is the Federal Reserve System, which inflates the currency and
creates its own set of winners and losers. Of course, as the Austrian
Economists have demonstrated, an economic boom fed by currency expansion
cannot sustain itself for long, and when the inevitable bust occurs, many
economic opportunities are lost.

As Ludwig von Mises and Murray Rothbard, along with other Austrian
Economists, have pointed out, methodology matters. The praxeological
method recognizes the importance of individual productivity and the role of
peaceful exchange. Modern neoclassical economics, on the other hand, has
embraced something that is unworkable and makes no sense when examined
carefully. Thus, when neoclassicals declare that capitalism is causing
inequality and sowing the seeds of its own destruction, remember that such
talk truly belongs in the marxian dustbin of history.

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William Anderson, an adjunct scholar of the Mises Institute, teaches economics at North Greenville College. Send him mail


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