Why Income Inequality Doesn’t Bother Me Much

Karl Muth offers his opinion on the growing debate around income inequality.

There’s a big to-do about income inequality in the U.S. and U.K.

Let’s establish a few things up-front.

I believe, as I think most people do, that the marginal product of labour of a given worker should be roughly equal to that person’s marginal wage for the work done. If you add ten dollars an hour of value to the corporation where you work, you should be paid around ten dollars an hour. It would surprise me (and others) if you were instead only paid a dollar an hour or paid one hundred dollars an hour, and in that case we would look to other factors like the competitiveness of the labour market where you live, in the sector your job inhabits, what peers and proxies could be used for analysis, and so on. This is what we do.

But the discussion about income inequality doesn’t centre on people being overpaid or underpaid, except in the most abstract sense. It instead focuses on control over the economy, where large amounts of money are going, the discrete case of CEO pay (which I’ve studied and written about extensively), other highly-paid workers (like right-tail trader incomes, a few people in the technology industry), and other issues. It also centres on perceived opportunity inequality, or what might be called "meritocracy glitches," more than differences in two particular incomes.

The truth is, despite what the editorial board at The New York Times might have you believe: Income inequality just doesn’t matter that much. And this is true no matter what your politics and no matter how much you care about abstract concepts like fairness, Aristotelian oughtness, or egalitarianism.

Why doesn’t it matter?

First of all, separate income from wealth. The wealthiest people in the world do not have particularly high incomes. A few do, but most have substantial wealth that has little to do with fluctuations in year-to-year income. In many years, they may have zero income or even negative income. Even a 99% tax rate on new income will have very little effect on these fortunes, but will have the regressive effect of allowing very few new fortunes and exacerbating the dominance of existing fortunes. In other words, the issue here is wealth inequality, not income inequality. If you look at the money spent by people of our generation who are very wealthy, often it is money that was initially made (note that I use the word made and not the word earned) prior to World War II, and often even during the Nineteenth Century. When I am in Hong Kong, this is particularly apparent: favours and party invitations from British governors who died decades ago still affect who has ten million dollars and who has five hundred million dollars.

Second, the income inequality issue has little to do with solving the network inequality issue, which is the key driver of the inequality people perceive as being problematic. People are not enraged when a neighbour wins the lottery, because this does not violate normative network rules and is not seen as injuring the perception of a prevailing meritocracy. But the social network issue is at the heart of the perception of meritocracy (or lack of meritocracy), as a better social network allows a higher frequency of contact with people who are useful professional contacts. In a completely unscientific exercise, I counted up the number of people I knew at age sixteen who now hold degrees from Harvard (this is an arbitrary metric, but it’s somewhat interesting nonetheless). By the time I was sixteen, I knew at least twenty-one people who now hold degrees from Harvard. Of these, seven were adults who had already graduated from Harvard, while fourteen were my peers (who I define as people yet to attend a university when I was sixteen) who would go on to attend Harvard at an undergraduate or graduate level. Perhaps there is a twenty-second secondary school acquaintance who went on to study at Harvard, but that person is smart enough to not be on Facebook. The point is that opportunity is inexorably intertwined with one’s social network. I’ve never formally interviewed for a job and I don’t think many of these friends have, either. In essence, by the time we received our driver’s licenses, we were already exempt from many of the rules and tests and hurdles that would face most other people later in life. It was not a matter of the “income inequality” between our parents and others’ parents – it was a matter of the network inequality we enjoyed and the network effects that are embedded in attendance at top institutions (to visualise these effects, think of it this way: the first one hundred members of the Harvard alumni network added little value, but the next ten thousand greatly increased the value of participating in this network).

Third, and this is the one that people may have trouble grasping at first glance, it’s just not that much money. That’s right, the amount of money being earned – by anyone – in a given year isn’t that much money. In macroeconomics and macro financial markets modeling (where we use instant liquidity and near-liquid-less-costs metrics), we look at “M3 plus money market” or “M3/MZM Blend” when we think about how much money there is in the world. We need to include in this number money held by governments, corporations, charities, and other entities, because these funds are, in finem, controlled by individuals (whether manager-owners or shareholders or others). The degree of control and the overlapping control premia that govern this relationship are fascinating, but unimportant to the instant discussion. Compared to the wealth in the world (which is about $230 trillion in aggregate M3 plus about $11 trillion more in blended money market estimates, so let’s call it around two hundred and forty trillion dollars, which is in line with estimates arrived at by other methodologies), what anyone is earning – even the highest-paid worker, the finis cauda – is not all that important compared to the wealth already out there in the world. It is less than a drop in a bucket and more akin to a drop in an ocean. Squabbling over how that drop is distributed may be intellectually worthy of debate, but it is embarrassingly unambitious as advocacy. Present-year income or how much money people make next year is almost irrelevant in the greater historical arc of who is wealthy and who is poor.

Fourth, the discussion of income inequality distracts from the larger question not only of wealth inequality but of net worth inequality. It might be helpful for every American with $150,000 in student loans and a $400,000 mortgage to have to fill out on his or her taxes that he or she has a negative net worth of $X. Perhaps it would remind these people, “That’s right, the person begging outside Starbucks has a higher net worth than you do.” The fact is that many people are put in substantial debt at a young age from which they never recover. I’m not claiming that people don’t pay off their mortgages and student loans, they certainly do. That isn’t what I mean by “recover.” But, in the meantime, they are forced to make conservative career decisions, are unable to pursue things that might make their lives happier or more fulfilling, are put in situations where they are unlikely to build networks that are useful to themselves – or their children – professionally, and so forth. Even people with very high incomes do not enjoy the advantages of the wealthy if they also must maintain a high debt burden. They do not enjoy the same opportunities that a person who graduates from a top university with no debt enjoys. And it is not a coincidence that it is these debt-free people who tend to take more risk, start more innovative companies, and so forth.

Fifth and finally, the “one percent” language and other class warfare rhetoric of the past ten years is inherently xenophobic and internationally ignorant. If we want to talk about income inequality, which you’ll notice I’ve avoided doing thusfar except to distinguish it from what might actually matter, then we should talk about income globally (just as I discussed the amount of money globally). In that case, anyone earning about forty-one thousand dollars a year is in the top one percent. Period. Well, not period. Because if you factor in all the people in the world with negative incomes (who live subsidized lives where their subsidy through international aid or other factors means their ‘real’ income is net negative, which you can calculate a number of ways, but aid budget subtraction against an estimated denominator is the easiest), you end up with everyone earning about twenty-eight thousand dollars a year or more being in the top one percent. We live in a world where studying the wealth gap by examining the incomes of the top one percent of earners in England is about as useful as evaluating the environment based only on the carbon emissions of Germany or examining the future of cinema based upon how many feature-length films were made in Denmark last year. That’s how little money, out of all the money in the world, was earned by those highly-paid bankers on Canary Wharf. And these anaologies, silly as they are, actually overstate – not understate – the salaries of these people (the carbon emissions of Germany are actually far more of the world’s total carbon emissions than the incomes of the UK’s workers are of the world’s income). If we want to examine wealth (and its trickling input, income) intelligently, we must do so globally and over a longer timeline than a year or decade.

The type of research The New York Times, The Guardian, and other outlets have gone out of their way to highlight in recent months does worse than confuse the issue, it confuses the reader. So, if you feel like reading fluff on the class divide, go on and read pieces like Daniel Goleman’s recent column, “Rich People Just Care Less”. If you feel like learning about these issues in some more relevant, coherent context, I highly recommend Law and Revolution by Harold Berman, a Harvard professor who passed away a few years ago; no book better explains the structures and systems that have created the wealth that exists today, in large quantities stuffed into small areas of our world. To know this history is to realise how we arrived at this predicament and that nothing about it is new.

Income inequality doesn’t bother me much because income is macroeconomically “slow” and easily changed in distribution. In order for today’s poor to be tomorrow’s consumers, enormous swings in income are necessary and desirable. Those in the right tail of the income distribution do not tend to have persistent fortunes; in fact, earners at lower income levels tend to have higher levels of both inter vivos and intergenerational wealth conservation – hence, income distribution does not have severe effects on wealth distribution on instant observation or over time. Meanwhile, other issues – like social network artifacts from generation to generation (or in certain geographies) and existing large pools of wealth are very difficult to move or alter directionally. Finally, the artificial and unhelpful national compartmentalisation of the wealth and income discussions does little to fuel intelligent debate on the underlying issues and actually makes the worthwhile aspects of the debate more difficult to discover and explore.

To complain about income inequality is like complaining about the drips of milk still coming from the carton, not having noticed the litre already spilt. Even if we were to fix everyone’s income at an equal amount for the next five or ten years, current trends would persist due to large amounts of “warehoused” wealth and social network inertia that is difficult to blunt through economic policy alone. That’s why income inequality, on its own, doesn’t bother me much. And probably shouldn’t bother you all that much, either.