Guest Post: Who's Afraid Of Income Inequality?
Submitted by James E. Miller of the Ludwig von Mises Institute of Canada,
Through decades of research, American neurobiologist James McGaugh discovered that as humans learn information and encounter new experiences, the part of the brain known a the amygdala plays a key role in retention. The amygadala is activated primarily by stress hormones and other emotionally arousing stimuli. Memory consolidation, or the forming of long term memories, is typically modulated very strongly by the amygdala. Put simply, events that invoke significant amounts of emotion make a bigger imprint on one’s brain.
Emotion, while an important element in man’s array of mental tools, can unfortunately triumph over reason in crucial matters. Excessive anger can lead to violent confrontations. Heartbreak can lead a person to do drastic things in order to woo back a lost lover. In the context of simple economic reasoning, today’s intellectual establishment often disregards common sense in favor of emotional-tinged policy proposals that rely on feelings of jealously, envy, and blind patriotism for validation rather than logical deduction. “Eat the rich” schemes such as progressive taxation and income redistribution are used by leftists who style themselves as champions of the poor. Plucking on the emotional strings of envy makes it easier to arouse widespread support for economic intervention via the state.
In the aftermath of the financial crisis of 2008, economic growth predictably slowed down in most industrialized countries. Many commentators on the political left have grasped onto this opportunity to point to the vast amount of income inequality which exists in the United States and reason that it played a part in causing the crash. This argument is typically paired with a proposal to raise taxes on the rich to balance out societal incomes. It is alleged that having government brutes step in order to play the role of Robin Hood is the best and most justified way to alleviate income inequality.
Presently, income inequality in America is at its highest peak in decades. In 2011, a study by the Congressional Budget Office concluded that after tax income grew by 275% for the top 1% of income earners between the years of 1979 and 2007. The top-fifth of the U.S. population saw a 10 percentage point increase in their share of total income in the same period while all other groups saw their share decrease by 2 to 3 percentage points. The data undoubtedly shows that income inequality has been increasing over the past few decades. New York Times columnist and economist Paul Krugman has latched onto the evidence and is suggesting that rising income inequality plays a part in causing recessions. Economist Joseph Stiglitz, who recently wrote the book “The Price of Inequality,” has argued that without a fair share of the national income, the middle class is unable to spend enough to keep aggregate demand elevated. Both economists see income inequality as a danger to the prosperity of a nation. Such a message is appealing to the greater public because it plays on their perceptions that the world is unfair. It almost seems intuitive to think that the rich posses too much wealth or that a prosperous society is one in which income is more equalized. Comfortableness in these beliefs paves the way for income redistribution efforts by the ever-scheming political class.
With income inequality a hot topic of debate going into the fifth year of the biggest economic downturn since the Great Depression, the question remains: does income inequality have a negative impact on society as Stiglitz and Krugman suggest? And is growing income inequality an inherit part of capitalism?
First and foremost, the idea of equality for man in physical attributes, mental fitness, and material security is essentially anti-human. The most appealing aspect of mankind is that every person varies from one another in a myriad of different ways. Some are better athletes, some are quicker studies, some have outer features that make them generally more attractive. It follows that some men and women will be more apt at producing or better attuned to the demands of the marketplace. They will have higher incomes by virtue of their own entrepreneurship or capacity to produce. So, in a sense, income inequality is a fact of the free market. But it is the possibility of inequality and the ability to achieve a higher income that makes capitalism work. Punishing those who excel at making consumers better off punishes the very market mechanism that leads to better living standards overall. In a free society, income inequality is not good or bad; it is part of the functioning order. Any attempt to make incomes more equal through state measures is unjustified plunder of the rightful earners of wealth.
But what of the inequality in income that exists in today’s state-corporatist economy? Did the 1% acquire its wealth solely through hard work? The answer is hardly in many cases. Though there are some innovative businessmen who became rich by providing new and better products, the sharp increase in income inequality over the past two decades is due to an economic phenomenon outside of normal market operations. Krugman and Stiglitz rightfully point out that the greatest periods of income inequality in the United States were the late 1920s and the period since the mid-1990s. What they fail to mention is that both these periods were not defined by capitalism run amok but by massive credit expansion. This expansion in credit, aided and abetted by the Federal Reserve’s loose money policy, is the real culprit behind vast income inequality. Economist George Reisman explains:
the new and additional funds created in credit expansion show up very soon in the financial markets, where they drive up the prices of securities, above all, common stocks. The owners of common stock are preponderantly wealthy individuals, who now find themselves the beneficiaries of substantial capital gains. These gains are the greater the larger and more prolonged the credit expansion is and the higher it drives the prices of shares. In the process of new and additional money pouring into the financial markets, investment bankers and stock speculators are in a position to reap especially great gains.
Since it’s so important, the main point just made needs to be repeated: credit expansion creates an artificial economic inequality by showing up in the stock market and driving up stock prices.
Money acts as a medium of exchange but is not neutral in its effects on receivership. Those first receivers are able to bid up the price of goods before any other market participants. As the newly created money flows into the economy, the general price level rises to reflect the new volume of currency. In practice, credit expansion which brings about a reduction in interest rates also increases the amount of time businesses can go without making deductions for depreciation on their balance sheets as they purchase capital goods. Because investment tends to go toward durable goods during periods of credit expansion, there is less funds left over to devote to labor. Profits end up being recorded while wages sag behind. Since credit expansion and inflationary policy go hand in hand in distorting relative prices and must eventually come to an end, the bust that occurs reveals wasteful investment. Recession sets in shortly thereafter.
Printed money is not the same as accumulated savings which would otherwise fund sustainable lines of investment. And it is only through adding to the economy’s pool of real savings that productive capacity is able to increase in the long term. The wealthy have a higher propensity to save precisely because they have a higher income. It is through their savings that new business ventures are funded and the economy is able to grow without the faux profits from government-enabled credit expansion. This is why raising taxes on the rich is a backwards solution to income inequality. Taxation only funnels money out of the productive, private sector and into the public sector which focuses on spending to meet political ends rather than consumer satisfaction. All government spending boils down to wasted capital. The truth is that capital is always scarce; there is never enough of it.
Pointing out this fact is by no means corporate shilling. Many corporations and well connected businesses lobby for tax increases in order to burden their competitors. Currently in California, Governor Jerry Brown is campaigning for a ballot measure which would raise taxes on the state’s richest residents. According to the Wall Street Journal, companies such as Disney, NBC, Warner Bros., Viacom, CBS, and Sony have each already pitched in $100,000 for the initiative. Various energy companies are financially supporting the ballot measure to make sure that a 25% tax on natural gas and oil extraction isn’t next. As the scope of government becomes all the more encompassing, big business starts seeing profit opportunity in using its forceful authority to better its own competitive position. In their unceasing tirades over income inequality, Stiglitz and Krugman recognize the trouble rent-seeking poses to competitive markets yet both reason that the problem doesn’t lie with the state but with those politicians and bureaucrats who occupy its enforcement offices. To put it bluntly, this notion isn’t just juvenile; it rests on the fallacious assumption that government is staffed by only the most well-meaning of individuals in society. As history and reason dictate however, good souls are not attracted to positions of absolute power. The state, by Max Weber’s definition, holds the monopoly over force in a given area. Practically every action taken by state officials introduces violence or the spoils from violence into an otherwise free society. It follows that only those seeking to use state authority for their own benefit naturally gravitate toward politics.
Krugman and Stiglitz believe, as most do, that Americans should be born with the opportunity to succeed. To create an environment of fairness, they propose a variety of government policies so that even the most impoverished individuals will have a shot at the American Dream. Their arguments rest largely on emotion instead of reason and are aimed at inspiring reactionary protest. What they fail to see (or refuse to acknowledge) is that the free market provides the best opportunities for someone to make a decent living by providing goods and services. In a totally uninhibited market, profits come only to those who satisfy consumers more than their competition. Contrary to Stiglitz’s suggestion, Henry Ford wasn’t a great businessman because he paid his workers a high wage. He made his fortune by streamlining the process from which cars were built in order to sell them at a lower price. The employees at Ford were able to increase their productivity, and thus wages, through the previous accumulation of capital and investment in machinery. Ford’s massive profits didn’t last long however as domestic and foreign competition copied the mass production model and were able to attract market share of their own. The greater the amount of cars on the market meant lower prices for all consumers in the end.
Again, in a truly free market the only way to maintain a rising income is to continually produce at a more efficient and more innovative rate. In an economy plagued by the heavy hand of government, the market becomes rigged in favor of those connected to the ruling establishment. Competition is decreased by the rising cost of adhering to regulations, innovation stagnates, and more income flows to the top. Through central banking and credit expansion, profits are able to be recorded by the financial industry and first receivers of money before the rest of the population; which in turn leads to further evidence of income inequality.
No matter how you slice it, taxation is theft. It is indiscernible from highway robbery and devoid of any moral justification. Income inequality is a problem not because the government isn’t doing enough to combat it but because politicians and bureaucrats never tire of intervening into the private affairs of society. With government intervention present in practically all market transactions, the solution to income inequality is to remove the intervention; not empower the state further by increasing the amount of funds at its disposal.