Thursday 30 March 2023

Income Inequality is Not the Same as Poverty

Income inequality does not necessarily imply higher levels of poverty.

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Over the years I have published a number of columns on inequality. Among these are “Fleeing Equality,” “Redistributive Injustice,” “The Rich Do Not Exist,” and others reproduced in my book “Reflections on Freedom.” Invariably, this topic brings me the most hateful correspondence. Undeterred, I will try again motivated, this time, by the excellent analysis presented by Steven Pinker in his latest book, “Enlightenment Now.”

Favela (slum) on the outskirts of Salvador de Bahia, Brazil. (World Bank).

Let’s begin by defining the terms as Voltaire demanded. I am defending only the inequality that results from legitimate creation of value in goods and services. The way in which inequality comes about matters. Those who get ahead as a result of government-granted privileges, unfair business practices, dishonesty, corruption, cronyism, etc., are engaging in illicit activities and must be prosecuted vigorously. What offends me is not inequality as such, but that inequality that results from illicit gains.

Let me borrow an example offered by Dr. Pinker. J. K. Rowling is the British novelist who created the Harry Potter series that sold more than 400 million copies. In her “rags to riches” life story, Rowling went from living on state benefits to being the world’s first billionaire author. She is one of the richest persons in the world, and has given away much of her fortune to charity.

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We have voluntarily handed over to Ms. Rowling a portion of our capital for the pleasure of reading her books, or watching the Harry Potter films. We made her very rich, thus increasing inequality, and this has not made anyone worse off. The same can be said of the products produced by Bill Gates’ Microsoft, Steve Jobs’ Apple, and so many others who have enhanced our lives, and we in turn rewarded them financially.

Wealth is not, in the overused analogy, a fixed size pie that needs to be forcibly distributed to achieve some artificial equality. Global wealth, as measured by economic growth, is a pie that is ever increasing, and providing larger slices for everyone. Although granted, the slices may not be of the same size for all.

And here is the paradox. As Pinker notes, life “must have begun in a state of original equality, because when there is no wealth, everyone has equal shares of nothing.” It is only when wealth begins to be created that some will end up with more than others. When a society starts to create meaningful opportunities for wealth, some people are likely to take greater advantages of those opportunities.

“Whether by luck, skill, or effort,” gains will be disproportionate. Absent some artificial income redistribution scheme, “absolute” inequality is a mathematical necessity. I placed “absolute” in quotations to distinguish it from “relative” inequality. Absolute inequality is the difference between the richest and the poorest. As countries get richer, some individual will get richer than others, but everyone will be relatively better off. What is relevant is how much we earn or consume, not how high or low we rank in relation to others.

Income inequality is notoriously difficult to measure. One of our best inequality measuring tools is the Gini coefficient in several versions. The Gini ratio works something like this. A Gini coefficient of zero means perfect equality, for example, if everyone has the same income. A Gini coefficient of one means that one person gets all the income – perfect inequality. In practice, Gini values range from 0.25 for the most egalitarian countries, to 0.70 for those with a highly unequal distribution. Poor African nations show high inequality, whereas wealthy Scandinavian nations are the most egalitarian.

Measurements get more complicated when we consider social transfers such as food stamps, and other assistance for needy families. In the late 2000s, the United States Gini coefficient before social transfers was 0.486; after transfers inequality decreases to 0.378. Even more interesting, if we measure the Gini coefficient on what we consume, rather than on income, the recently reported increase in inequality disappears.

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The Gini coefficients shows that inequality worldwide is declining, but we make an analytical and moral mistake when we focus narrowly on income inequality. What is really important is how well-off people are, not how they rank in relation to others.


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