Economic Myths #13 - Wealth Inequality and "The 1%"

[First published on Free Life]

The inequality of wealth and income is a frequent bone of contention in the mainstream media. According to The Guardian, 1% of the world’s population will own two-thirds of its wealth by the year 2030. A typical response to this kind of revelation is the following utterance from the Executive Director of Oxfam in 2015:

The mainstream debate over this issue fails to understand the true nature of the problem (although, interestingly, The Guardian article referred to above is unusually far sighted in recognising some of the causes of inequality).

The pro-free market side is wont to point out that such inequality “doesn’t matter” and that governments should not do anything to interfere with the progress of business. The likely call from the opposite side, however, is for increased taxation and redistribution and, indeed, Oxfam itself stressed the need for a greater crackdown on tax avoidance by large, multinational corporations. However, the reality is much more nuanced than the false dichotomy between “pro-business” and “pro-government/anti-poverty”.

On the one hand, we can agree that wealth inequality does not, on its own, create any problems for the generation of wealth and the reduction of poverty. The common attitude towards the rich appears to assume that someone like Warren Buffett or Bill Gates has tens of billions of dollars lying around in a bank account for them to spend and enjoy.

The reality is that these figures represent the value of capital goods – machines, tools, factories and so on – that are invested in producing goods and services that everyone wants to buy. If these resources are in the hands of just a few people – say, “the 1%” – who most accurately devote them to the most urgently desired needs of consumers, then there is nothing economically deleterious with wealth inequality. Indeed, wealth inequality, in this scenario, is exceedingly good as any attempt to reduce it would divert resources into the hands of those less capable of directing them to the ends that people desire, or into the hands of those who would consume them. It is capital investment – more capital invested in more production processes to churn out more products that people need – not taxes and redistribution that solves the plight of poverty.

However, this scenario is conditional upon the crucial aspect that resources must be in the hands of those who are best suited to serving the needs of consumers. In other words, those who are rich must have become so by meeting those needs. Unfortunately, it is patently obvious that the current ownership structure does not reflect the voluntary choices of consumers. Rather, it is the product of crony capitalism, of cheap printed money that is ploughed into malinvestments, and of taxpayer funded bail outs when it all collapses. The growth in wealth inequality is due not to the fact that consumers are voluntarily choosing to place that wealth in the hands of a few select people; it is because the government is throwing cheap money at this tiny elite so they can steal all of the world’s assets.

What, then, is the solution to this problem? Taxation and redistribution would clearly compound the economic evils rather than solve them. And, in any case, in spite of the hullaballoo about tax avoidance, the rich will always be able to influence tax policy to their benefit and to arrange their affairs so as to avoid it as much as possible.

Instead, what is needed is a wholesale withdrawal of the state from either supporting or hindering anyone in the pursuit of gaining wealth. All wealth should be obtained through the voluntary nexus of serving the needs of consumers and everyone should gain their riches through their abilities and not through their political connections.

One interesting question is what might such a world look like? Would it encourage wealth inequality or would such inequality be unlikely?

On the one hand, it is arguable that wealth would still be highly concentrated. Genuine entrepreneurship is a rare talent and is likely to always remain so. On the other hand, however, if that is the case it is also likely that those particular individuals who own the world’s resources will rotate relatively quickly, with the top dogs remaining on the pedestal for only a short time. Indeed one aspect of the current wealth divide that is ignored is whether the same people remain stuck within their wealth/income group or whether there is relatively fluid movement between the different groups.

Successful entrepreneurs make their biggest successes when they are small, nimble and contrarian. Once they have achieved their wealth, however, and their enterprises have morphed into large, multinational companies, they become large, unwieldy, inefficient and complacent. A former rebel becomes a part of the establishment who then becomes vulnerable to the insights of later entrepreneurs.

This can perhaps be illustrated with the technology industry where no, single player has managed to dominate each successive era. Microsoft put a PC into everyone’s home in the 1980s-90s; Google was the number one in internet search; Facebook was on top with social networking; and we are now, seemingly, in a fourth phase where Apple dominates smartphone technology and other hand-held devices. No single outfit has been able to carry through its dominance from one era to the next. Corporate dynasties and everlasting companies controlling everything will certainly not be a feature of a genuinely free market.

Even a stock investor such as Warren Buffett, who has profited from a great many businesses in numerous decades, would be unlikely to achieve the wealth that he has done. Buffett’s mantra of value investing relies upon the price of a stock to fall below the underlying value of the business, and for the price to then reach parity with, or exceed, that value. But the large distortions in stock prices – both up and down – have occurred precisely because of central banks flooding the markets with cheap, freshly printed money that results in excessive booms and busts. It is unlikely that Buffett, in a genuine free market, would have been able to buy and sell at such favourable prices as he was able to do in recent decades.

The same phenomenon also accounts for the wealth of Amazon CEO Jeff Bezos, who currently [2018] occupies the top spot on the list of the world’s richest individuals. As successful as Amazon has been, Bezos is unlikely to have achieved his level of wealth without Amazon having been one of the seemingly over-hyped and over-privileged “FAANG” (Facebook, Amazon, Apple, Netflix, Google) stocks, which have been the main beneficiaries of the artificial, stock market gains since 2008.

Moreover, it is also possible that a free market would serve to make capital ownership more diffuse. As wealth creation ensues and the standard of living rises, ordinary people will find themselves with increasing amounts of disposable income that they may decide to divert into saving rather than increased consumption. Such funds, through savings accounts and the bond market, may form the backbone of investment funds that are ploughed into productive use. Thus, ownership of the claims on the proceeds of production may be more diverse than it is at present.

Either way, however, we can be sure that the resulting structure of production and ownership will be one that best serves the desires of consumers, changing and adapting as the tastes of consumers change. Ultimately, it will always be the everyday folk, through their purchasing habits, who decide on the level of wealth inequality – not the state and central banks handing out favours to their political cronies.