Tuesday, April 5, 2011

In defense of inequality

The dark and evil bugbear of income inequality is making the rounds again.

The problem: a tiny sliver of the people own a huge portion of 'the wealth'.  According to Stiglitz, the top 1% of Americans control 40% of the wealth.  If you don't understand economics, (or in Stiglitz' case, you have a political agenda), this is a 'problem'.  The assumption is that these massively wealthy people have taken their filthy riches from the rest of us poor slobs.  They *must* have done something to us, something wrong.  Nobody should be that wealthy - it's disgusting.

The answer from the left is that this money should be taken from the wealthy, and redistributed 'fairly' to the rest of us.

Whether you subscribe to this idea or not, I've got some news for you.  The 'problem' is only going to get worse.  I believe that the factors responsible for the current distribution of wealth will only become more powerful over time.  But I'm here to tell you why it's *not* a problem, and you shouldn't be worried, or angry, or resentful.

First, some remedial economics.  Sorry if this is boring, but it's critical to understanding wealth and its distribution.

Take a CEO - a real fatcat like ING's Jan Hommen.  Why does he earn so much money?  What could he possibly do that would justify a £1m bonus?

CEO's are like any other employee: their wages are subject to the laws of supply and demand.  And the truth is, the supply of people with the business experience, the training, the track record, the sophistication, and the wardrobe necessary to run a bank like ING is limited.  Imagine the consequences if the Dutch were to pass a law limiting his total salary, stock, and benefits of all kinds to £200,00/year.  This lower wage would make the job a lot less attractive.  At that salary, a job as a government clerk, or an airline pilot, or a dentist, might seem a better deal - one with a lot less stress.  ING will be unable to compete in the global marketplace for CEO's.  [How would they respond?  Naturally, they'll have to weasel out of the law somehow, or go out of business due to their inability to hire sufficient talent to run the company.  Has society benefitted?]

Why is his income so high?  Because prices are signals.  And wages are simply the price the company must pay to hire him.  A high wage - in any occupation - is a signal to the market that more supply is needed.  When your mother tried to get you to go to medical school, she was responding to that signal.  If the supply is allowed to grow, the wages will eventually come down, until they reach an equilibrium.

By pressuring ING to take away Jan Hommen's bonus - you hamstring the bank at a critical time.  Think about it.  When times are good, the economy is soaring, and profits are rolling in - do you really need that world-class banking expert as your CEO?  Or do you need them the most when everything is falling apart?  Or during the recovery?

It's currently in fashion to hate bankers, stock brockers, basically anybody that has anything to do with finance.  This is a backlash from the 2008 crisis.  And some of that emnity is deserved.  But spare a few moments while I try to defend these folks.

Look at Larry Page and Sergey Brin.  Almost nobody hates those guys, or resents their wealth.  They clearly deserve it.  They provide services that the entire world uses - Google probably greases the wheels of commerce in ways that we don't even understand yet.  But most people don't actually understand what they did, or what they do.  To most people it's technical gibberish.  But the market understands what they do.  Most of their vast holdings right now are not in a sense a 'reward' for creating Google - but rather a massive bet by the market that they'll continue to innovate and create even more wealth.  This is price signalling at work again.

But those guys in finance that you despise - they also do stuff - stuff that you might not understand - stuff that the markets value highly.  Just because you don't understand it doesn't mean it's not real, or that they don't deserve their income.

So is this really a problem?  Is there some way that Jan Hommen's, or Larry Page's salaries make you worse off?  Did they really take that money from you?  Of course not.  And in fact, in both cases you probably derive some benefit from their existence.  Taking their wealth away wouldn't improve things, and could make things worse.  How many young Stanford computer science students will want to give up the security of a comfortable job at Cisco for the risky life of an entrepreuner - when the only reward is to be vilified by society?

This resentment of other people's wealth stems from a broken world-view.  Subscribers to this view imagine that wealth is an island - an island that everyone has to share.  If Bill Gates owns 10% of that island, and you live in a tiny closet, then clearly something is unfair.  But this metaphor is completely wrong.  Wealth is created - rather than picturing an island, think of the Netherlands.  Over the past several hundred years, the Dutch have carved their land from the North Sea by filling it in.  This is what entrepreneurs do - they create wealth that wasn't there before.  And believe it or not, they don't keep all of the wealth they create - they share it with the rest of us.  This newly-created land then provides a place for the growing of a 'crop' of future wealth.

Now, think about that 'top 1% controlling 40% of the wealth' problem again.  Rather than seeing a wealthy man or woman that has stolen land from you - you should now see a bold entrepreneur - someone who risked their capital and their time to create new land for everyone to share.  It shouldn't be surprising that the people who are the most adept at creating new land should be sitting on big portions of that new land.

Now I don't mean for this to be an apologia for every 'filthy rich crook' in America.  In reality, there are quite a few people who are undeservedly wealthy - people who actually *have* taken land from others rather than creating new land.  Often, these are people who take advantage of government or monopoly power to fleece either their customers or the taxpayers.  We all know who the 'crooks' are - even if they don't break a law (perhaps because they lobbied for a loophole?).  I'm not defending those guys.  What I'm saying is that you shouldn't automatically assume that all billionaires are crooks.  Or even that most of them are.

Ok, now for the bad news.  I think the 'problem' is only going to get worse.  Twenty years ago, the canonical 'filthy rich guy' was an Oil Baron or a Saudi Sheik.  Today, the names that come to mind are of young technocrats, instant rock stars like Page & Brin, or Mark Zuckerberg.  Their meteroic rise in fame and wealth are hints of the world to come.  Our society is speeding up.  Information and capital move at a blinding speed - a speed that will seem glacially slow only a few years from now.  Technology is making possible huge leaps in productivity - and productivity is the main engine of society's wealth creation.

So I see over the next few decades an ever-widening distribution of wealth.  Using our 'land-creation' metaphor, the North Sea will be filled faster and faster as time goes by.  If the broken 'island' metaphor takes hold, then resentment and anger will rise, too.  But if we can get people to understand what's really going on, maybe we can avoid a foolish class war.