TCS Daily

Is Inequality a Useful Measure of Prosperity?

By Josh Hendrickson - November 15, 2007 12:00 AM

Debates about income inequality continue to come to the forefront. Dani
Rodrik recently claimed on his blog that market fundamentalists view "recent
trends in wealth and income inequality through pink eye glasses."
Similarly, Paul Krugman has written an entire book on inequality and even
claims there has been a return to the Gilded Age. These claims are clearly
lacking as they are framed through a false dilemma and are predicated on a
weak measure of prosperity.

Those who are concerned with income inequality often present their argument
as though there are two choices. One can either side with the market
fundamentalists whose "blind faith" claims that the market will work itself
out or they can side with "realists" who believe government intervention is
necessary to correct for this market failure. However, this is a false
dilemma. As Arnold Kling so eloquently explained, there are many of us who
concede that markets fail, but we are much more concerned with government
failure. And there is certainly reason to believe that the government will
fail to equalize economic outcomes. For example, the most frequent solution
to income inequality, and the one advocated by Krugman in nearly every
interview about his book, is higher taxes on those at the top of the income
scale. While this may give the appearance of lessening inequality, in
actuality it does very little. Essentially, it is equivalent to twisting
the ankle of the fastest runner in the world in an attempt to make other
runners faster. In no way does this make other runners faster.

Even looking beyond the likelihood of government failure, there is a far
more important reason for lacking trepidation about income inequality.
First, income inequality is a static measure of well-being. Looking at an
individual's or group's share of income at a given point in time tells us
very little. In fact, even looking at the trends in income inequality is
futile. The fact that individual's rarely remain in the same income group
throughout their lives suggests that looking that a group defined as "poor"
or "middle class" or "rich" is irrelevant.

Second, and perhaps most importantly, is the simple fact is that income
inequality is a poor measure of prosperity. In reality, economic growth and
innovation will do more to help the poor and the middle class than any
conceivable government policy.

In Capitalism, Socialism, and Democracy, Joseph Schumpeter discusses the
benefits of capitalism at long length. Perhaps his most important argument
is the one in which he explains why invention and innovation benefit those
with lower incomes a great deal more than those who are rich. He points out
that, "it is the cheap cloth, the cheap cotton and rayon fabric, boots,
motorcars and so on that are the typical achievements of capitalist
production, and not as rule improvements that would mean much to the rich
man." Imagine, for example, washing clothes without a washing machine. To
whom did the washing machine benefit more? It was the individuals who could
not hire others to wash their clothes.

Unfortunately, Schumpeter's message seems to have fallen on deaf ears among
the supposed market realists. They have become too focused on imperfect
measures of prosperity and, to make matters worse, they advocate policies
that merely propose an aesthetic solution. Those of us with "pink eye
glasses" are not necessarily market fundamentalists; we merely recognize the
fact that there are better measures of prosperity and that there is more to
fear from the government than from markets.

Josh Hendrickson teaches economics at Wayne State University. He also
maintains the blog entitled, "The Everday Economist."


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