Income Inequality And Poverty Essay Example





January 2016

Since the 1970s, economic inequality in the US has increased dramatically. And in particular, the rich have gotten a lot richer. Nearly everyone who writes about the topic says that economic inequality should be decreased.

I'm interested in this question because I was one of the founders of a company called Y Combinator that helps people start startups. Almost by definition, if a startup succeeds, its founders become rich. Which means by helping startup founders I've been helping to increase economic inequality. If economic inequality should be decreased, I shouldn't be helping founders. No one should be.

But that doesn't sound right. So have we just shown, by reductio ad absurdum, that it's false that economic inequality should be decreased? That doesn't sound right either. Surely it's bad that some people are born practically locked into poverty, while at the other extreme fund managers exploit loopholes to cut their income taxes in half.

The solution to this puzzle is to realize that economic inequality is not just one thing. It consists of some things that are bad, like kids with no chance of reaching their potential, and others that are good, like Larry Page and Sergey Brin starting the company you use to find things online.

If you want to understand economic inequality—and more importantly, if you actually want to fix the bad aspects of it—you have to tease apart the components. And yet the trend in nearly everything written about the subject is to do the opposite: to squash together all the aspects of economic inequality as if it were a single phenomenon.

Sometimes this is done for ideological reasons. Sometimes it's because the writer only has very high-level data and so draws conclusions from that, like the proverbial drunk who looks for his keys under the lamppost, instead of where he dropped them, because the light is better there. Sometimes it's because the writer doesn't understand critical aspects of inequality, like the role of technology in wealth creation. Much of the time, perhaps most of the time, writing about economic inequality combines all three.

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The most common mistake people make about economic inequality is to treat it as a single phenomenon. The most naive version of which is the one based on the pie fallacy: that the rich get rich by taking money from the poor.

Usually this is an assumption people start from rather than a conclusion they arrive at by examining the evidence. Sometimes the pie fallacy is stated explicitly:
...those at the top are grabbing an increasing fraction of the nation's income—so much of a larger share that what's left over for the rest is diminished.... [1]
Other times it's more unconscious. But the unconscious form is very widespread. I think because we grow up in a world where the pie fallacy is actually true. To kids, wealth is a fixed pie that's shared out, and if one person gets more it's at the expense of another. It takes a conscious effort to remind oneself that the real world doesn't work that way.

In the real world you can create wealth as well as taking it from others. A woodworker creates wealth. He makes a chair, and you willingly give him money in return for it. A high-frequency trader does not. He makes a dollar only when someone on the other end of a trade loses a dollar.

If the rich people in a society got that way by taking wealth from the poor, then you have the degenerate case of economic inequality where the cause of poverty is the same as the cause of wealth. But instances of inequality don't have to be instances of the degenerate case. If one woodworker makes 5 chairs and another makes none, the second woodworker will have less money, but not because anyone took anything from him.

Even people sophisticated enough to know about the pie fallacy are led toward it by the custom of describing economic inequality as a ratio of one quantile's income or wealth to another's. It's so easy to slip from talking about income shifting from one quantile to another, as a figure of speech, into believing that is literally what's happening.

Except in the degenerate case, economic inequality can't be described by a ratio or even a curve. In the general case it consists of multiple ways people become poor, and multiple ways people become rich. Which means to understand economic inequality in a country, you have to go find individual people who are poor or rich and figure out why. [2]

If you want to understand change in economic inequality, you should ask what those people would have done when it was different. This is one way I know the rich aren't all getting richer simply from some new system for transferring wealth to them from everyone else. When you use the would-have method with startup founders, you find what most would have done back in 1960, when economic inequality was lower, was to join big companies or become professors. Before Mark Zuckerberg started Facebook, his default expectation was that he'd end up working at Microsoft. The reason he and most other startup founders are richer than they would have been in the mid 20th century is not because of some right turn the country took during the Reagan administration, but because progress in technology has made it much easier to start a new company that grows fast.

Traditional economists seem strangely averse to studying individual humans. It seems to be a rule with them that everything has to start with statistics. So they give you very precise numbers about variation in wealth and income, then follow it with the most naive speculation about the underlying causes.

But while there are a lot of people who get rich through rent-seeking of various forms, and a lot who get rich by playing games that though not crooked are zero-sum, there are also a significant number who get rich by creating wealth. And creating wealth, as a source of economic inequality, is different from taking it—not just morally, but also practically, in the sense that it is harder to eradicate. One reason is that variation in productivity is accelerating. The rate at which individuals can create wealth depends on the technology available to them, and that grows exponentially. The other reason creating wealth is such a tenacious source of inequality is that it can expand to accommodate a lot of people.

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I'm all for shutting down the crooked ways to get rich. But that won't eliminate great variations in wealth, because as long as you leave open the option of getting rich by creating wealth, people who want to get rich will do that instead.

Most people who get rich tend to be fairly driven. Whatever their other flaws, laziness is usually not one of them. Suppose new policies make it hard to make a fortune in finance. Does it seem plausible that the people who currently go into finance to make their fortunes will continue to do so, but be content to work for ordinary salaries? The reason they go into finance is not because they love finance but because they want to get rich. If the only way left to get rich is to start startups, they'll start startups. They'll do well at it too, because determination is the main factor in the success of a startup. [3] And while it would probably be a good thing for the world if people who wanted to get rich switched from playing zero-sum games to creating wealth, that would not only not eliminate great variations in wealth, but might even exacerbate them. In a zero-sum game there is at least a limit to the upside. Plus a lot of the new startups would create new technology that further accelerated variation in productivity.

Variation in productivity is far from the only source of economic inequality, but it is the irreducible core of it, in the sense that you'll have that left when you eliminate all other sources. And if you do, that core will be big, because it will have expanded to include the efforts of all the refugees. Plus it will have a large Baumol penumbra around it: anyone who could get rich by creating wealth on their own account will have to be paid enough to prevent them from doing it.

You can't prevent great variations in wealth without preventing people from getting rich, and you can't do that without preventing them from starting startups.

So let's be clear about that. Eliminating great variations in wealth would mean eliminating startups. And that doesn't seem a wise move. Especially since it would only mean you eliminated startups in your own country. Ambitious people already move halfway around the world to further their careers, and startups can operate from anywhere nowadays. So if you made it impossible to get rich by creating wealth in your country, people who wanted to do that would just leave and do it somewhere else. Which would certainly get you a lower Gini coefficient, along with a lesson in being careful what you ask for. [4]

I think rising economic inequality is the inevitable fate of countries that don't choose something worse. We had a 40 year stretch in the middle of the 20th century that convinced some people otherwise. But as I explained in The Refragmentation, that was an anomaly—a unique combination of circumstances that compressed American society not just economically but culturally too. [5]

And while some of the growth in economic inequality we've seen since then has been due to bad behavior of various kinds, there has simultaneously been a huge increase in individuals' ability to create wealth. Startups are almost entirely a product of this period. And even within the startup world, there has been a qualitative change in the last 10 years. Technology has decreased the cost of starting a startup so much that founders now have the upper hand over investors. Founders get less diluted, and it is now common for them to retain board control as well. Both further increase economic inequality, the former because founders own more stock, and the latter because, as investors have learned, founders tend to be better at running their companies than investors.

While the surface manifestations change, the underlying forces are very, very old. The acceleration of productivity we see in Silicon Valley has been happening for thousands of years. If you look at the history of stone tools, technology was already accelerating in the Mesolithic. The acceleration would have been too slow to perceive in one lifetime. Such is the nature of the leftmost part of an exponential curve. But it was the same curve.

You do not want to design your society in a way that's incompatible with this curve. The evolution of technology is one of the most powerful forces in history.

Louis Brandeis said "We may have democracy, or we may have wealth concentrated in the hands of a few, but we can't have both." That sounds plausible. But if I have to choose between ignoring him and ignoring an exponential curve that has been operating for thousands of years, I'll bet on the curve. Ignoring any trend that has been operating for thousands of years is dangerous. But exponential growth, especially, tends to bite you.

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If accelerating variation in productivity is always going to produce some baseline growth in economic inequality, it would be a good idea to spend some time thinking about that future. Can you have a healthy society with great variation in wealth? What would it look like?

Notice how novel it feels to think about that. The public conversation so far has been exclusively about the need to decrease economic inequality. We've barely given a thought to how to live with it.

I'm hopeful we'll be able to. Brandeis was a product of the Gilded Age, and things have changed since then. It's harder to hide wrongdoing now. And to get rich now you don't have to buy politicians the way railroad or oil magnates did. [6] The great concentrations of wealth I see around me in Silicon Valley don't seem to be destroying democracy.

There are lots of things wrong with the US that have economic inequality as a symptom. We should fix those things. In the process we may decrease economic inequality. But we can't start from the symptom and hope to fix the underlying causes. [7]

The most obvious is poverty. I'm sure most of those who want to decrease economic inequality want to do it mainly to help the poor, not to hurt the rich. [8] Indeed, a good number are merely being sloppy by speaking of decreasing economic inequality when what they mean is decreasing poverty. But this is a situation where it would be good to be precise about what we want. Poverty and economic inequality are not identical. When the city is turning off your water because you can't pay the bill, it doesn't make any difference what Larry Page's net worth is compared to yours. He might only be a few times richer than you, and it would still be just as much of a problem that your water was getting turned off.

Closely related to poverty is lack of social mobility. I've seen this myself: you don't have to grow up rich or even upper middle class to get rich as a startup founder, but few successful founders grew up desperately poor. But again, the problem here is not simply economic inequality. There is an enormous difference in wealth between the household Larry Page grew up in and that of a successful startup founder, but that didn't prevent him from joining their ranks. It's not economic inequality per se that's blocking social mobility, but some specific combination of things that go wrong when kids grow up sufficiently poor.

One of the most important principles in Silicon Valley is that "you make what you measure." It means that if you pick some number to focus on, it will tend to improve, but that you have to choose the right number, because only the one you choose will improve; another that seems conceptually adjacent might not. For example, if you're a university president and you decide to focus on graduation rates, then you'll improve graduation rates. But only graduation rates, not how much students learn. Students could learn less, if to improve graduation rates you made classes easier.

Economic inequality is sufficiently far from identical with the various problems that have it as a symptom that we'll probably only hit whichever of the two we aim at. If we aim at economic inequality, we won't fix these problems. So I say let's aim at the problems.

For example, let's attack poverty, and if necessary damage wealth in the process. That's much more likely to work than attacking wealth in the hope that you will thereby fix poverty. [9] And if there are people getting rich by tricking consumers or lobbying the government for anti-competitive regulations or tax loopholes, then let's stop them. Not because it's causing economic inequality, but because it's stealing. [10]

If all you have is statistics, it seems like that's what you need to fix. But behind a broad statistical measure like economic inequality there are some things that are good and some that are bad, some that are historical trends with immense momentum and others that are random accidents. If we want to fix the world behind the statistics, we have to understand it, and focus our efforts where they'll do the most good.









Notes

[1] Stiglitz, Joseph. The Price of Inequality. Norton, 2012. p. 32.

[2] Particularly since economic inequality is a matter of outliers, and outliers are disproportionately likely to have gotten where they are by ways that have little do with the sort of things economists usually think about, like wages and productivity, but rather by, say, ending up on the wrong side of the "War on Drugs."

[3] Determination is the most important factor in deciding between success and failure, which in startups tend to be sharply differentiated. But it takes more than determination to create one of the hugely successful startups. Though most founders start out excited about the idea of getting rich, purely mercenary founders will usually take one of the big acquisition offers most successful startups get on the way up. The founders who go on to the next stage tend to be driven by a sense of mission. They have the same attachment to their companies that an artist or writer has to their work. But it is very hard to predict at the outset which founders will do that. It's not simply a function of their initial attitude. Starting a company changes people.

[4] After reading a draft of this essay, Richard Florida told me how he had once talked to a group of Europeans "who said they wanted to make Europe more entrepreneurial and more like Silicon Valley. I said by definition this will give you more inequality. They thought I was insane—they could not process it."

[5] Economic inequality has been decreasing globally. But this is mainly due to the erosion of the kleptocracies that formerly dominated all the poorer countries. Once the playing field is leveler politically, we'll see economic inequality start to rise again. The US is the bellwether. The situation we face here, the rest of the world will sooner or later.

[6] Some people still get rich by buying politicians. My point is that it's no longer a precondition.

[7] As well as problems that have economic inequality as a symptom, there are those that have it as a cause. But in most if not all, economic inequality is not the primary cause. There is usually some injustice that is allowing economic inequality to turn into other forms of inequality, and that injustice is what we need to fix. For example, the police in the US treat the poor worse than the rich. But the solution is not to make people richer. It's to make the police treat people more equitably. Otherwise they'll continue to maltreat people who are weak in other ways.

[8] Some who read this essay will say that I'm clueless or even being deliberately misleading by focusing so much on the richer end of economic inequality—that economic inequality is really about poverty. But that is exactly the point I'm making, though sloppier language than I'd use to make it. The real problem is poverty, not economic inequality. And if you conflate them you're aiming at the wrong target.

Others will say I'm clueless or being misleading by focusing on people who get rich by creating wealth—that startups aren't the problem, but corrupt practices in finance, healthcare, and so on. Once again, that is exactly my point. The problem is not economic inequality, but those specific abuses.

It's a strange task to write an essay about why something isn't the problem, but that's the situation you find yourself in when so many people mistakenly think it is.

[9] Particularly since many causes of poverty are only partially driven by people trying to make money from them. For example, America's abnormally high incarceration rate is a major cause of poverty. But although for-profit prison companies and prison guard unions both spend a lot lobbying for harsh sentencing laws, they are not the original source of them.

[10] Incidentally, tax loopholes are definitely not a product of some power shift due to recent increases in economic inequality. The golden age of economic equality in the mid 20th century was also the golden age of tax avoidance. Indeed, it was so widespread and so effective that I'm skeptical whether economic inequality was really so low then as we think. In a period when people are trying to hide wealth from the government, it will tend to be hidden from statistics too. One sign of the potential magnitude of the problem is the discrepancy between government receipts as a percentage of GDP, which have remained more or less constant during the entire period from the end of World War II to the present, and tax rates, which have varied dramatically.

Thanks to Sam Altman, Tiffani Ashley Bell, Patrick Collison, Ron Conway, Richard Florida, Ben Horowitz, Jessica Livingston, Robert Morris, Tim O'Reilly, Max Roser, and Alexia Tsotsis for reading drafts of this.

Note: This is a new version from which I removed a pair of metaphors that made a lot of people mad, essentially by macroexpanding them. If anyone wants to see the old version, I put it here.



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Close observers of the development scene will have noticed an interesting shift over the past few years. Where once institutions such as the World Bank and charities like Oxfam described their goal as simply ‘ending poverty’, today they tend to frame things in terms of poverty andinequality. Well, that makes sense: doesn’t it seem intuitively obvious that these two things must be connected in some way?

Yet those links can be surprisingly hard to bring into focus. In 15 years of working in the development sector – first for international NGOs and more recently running a research programme on poverty and inequality – I have found myself explaining over and over again exactly what the one has to do with the other. What does it matter to an impoverished farmer in South Sudan if 85 people hold as much wealth as half the world’s population? If those 85 people gave everything away, would that actually help the farmer?

The problem, I have come to think, is that there are two very different ways of thinking about inequality. The first is all about the rich. The second is all about the poor. The first is the one we usually hear about. The second is the one that really matters.

The first, of course, is the one that preoccupies most writers and commentators on the question. The dominant metaphor seems to be a sort of global seesaw, with a few hugely rich individuals weighing down one end and the rest of us clinging for dear life to the other. As Thomas Piketty’s Capital in the 21st Century (2014) demonstrates, the rich have been getting richer much faster than the rest of us, so the seesaw is getting ever more skewed. And so inequality is big news right now. Two things, in particular, are remarkable about the current debate. The first is how many people are having it – not just the usual suspects, but lesser-known lefty agitators including the Pope, President Barack Obama, the managing director of the International Monetary Fund (IMF) and the head of the Bank of England. One would think that a robust response was inevitable.

But perhaps not, because the second remarkable thing is the dearth of actual policy ideas. Piketty’s imagined tax on capital is probably the only part of his book that has not met with near-universal acclaim. Mark Carney of the Bank of England and Christine Lagarde of the IMF talk vaguely about curbing pay and making tax ‘more progressive without being excessive’ (whatever that means), but governments do not seem to be rallying to that call. We are left to pore over cultural artefacts such as the Financial Times’s ‘How to Spend It’ supplement – a publication that might as well be a Trojan Horse operation designed to fan the flames of class warfare. Here we glimpse a world where a special supplement on luxury yachts is a viable commercial proposition, where one might spend £6,000 on a dress because it looked good on the model, and where private jets are simply a practical transport solution. Few people live here, but it’s a very recognisable address.

As a matter of fact, the runaway incomes of the super-rich do have a link to poverty. Where inequality is high and governments are pressured to reduce taxes on the rich, government income goes down and there’s less money for the kind of public spending that reduces poverty. Such considerations lead naturally to the common proposition that we might sort things out by taking money from the rich. We could cut down on tax avoidance, for example, or limit pay, or tax capital. Would that work? Well, it might. Then again, it might not. If governments make very rich people a bit poorer by changing tax or inheritance rules, who’s to say the money won’t just be spent on missiles or grandiose infrastructure projects or other things that people don’t really want, and which certainly won’t help to tackle extreme poverty? This is a story that leaves many questions unanswered. To start filling in the blanks, we need to look, not at the top of the wealth distribution, but at the bottom; not at the inequalities that make people rich, but the ones that keep people poor.

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Look at that seesaw again. It’s tempting to picture the people on it as atomised individuals, randomly distributed between the two sides. But in fact they aren’t like that at all. People don’t end up among the very rich, or languish on the side of the very poor, by chance. Rather, their position depends to a remarkable degree on the groups that they belong to. Where do they live? What is their ethnic group or religion? Do they have a mental illness or a physical disability? What family do they come from?

Take education. Between 1999 and 2011, the number of children in the world who were not in school fell by around half. Good news. But who are the half who didn’t benefit from this general improvement – the children on the wrong side of the education seesaw? The data on this is not as good as it should be (of which more later). But it’s likely, globally, that around two-thirds of children lacking education are from an ethnic minority in their own country. That’s useful information. The deck appears to be stacked against certain people in very predictable ways.

The inequalities underlying patterns of poverty and exclusion are always complicated. In Burkina Faso, for example, just under a third of children complete primary school. Trying to understand the barriers faced by the two-thirds who don’t attend school involves sifting through a lot of data. Sexism is clearly part of the story: 34 per cent of boys complete school compared with only 24 per cent of girls. But in this case the biggest inequalities are not based on gender.

Much more striking is the fact that 53 per cent of children in the central region of Burkina Faso finish primary school compared with 8 per cent of children in the most remote Sahel region; that’s a gap of 45 per cent. And the worst-off are from the minority Tuareg ethnic group, where only 3 per cent finish primary school. If governments want to improve education and get all children into school, they have to understand the pattern of inequalities that underlie the national figures. Otherwise, they can’t make effective use of resources, public education campaigns, political attention or anything else.

Where governments do want to tackle inequalities, doing so on the basis of groups can have impressive results. Take Bolivia, one of the most unequal nations on Earth. The government of Evo Morales came to power in 2005 on the basis of a programme to tackle the quite staggering levels of inequality in the country. In Bolivia, inequality has a racial face: indigenous people have a poverty rate approximately double that of the white population.

Morales made an explicit commitment to tackle the ethnic dimensions of inequality and poverty. The government started a cash-transfer programme. It made road-building a priority in order to link up the remote areas where indigenous people live. It has started programmes to persuade indigenous populations to attend university, and to encourage greater linguistic diversity within the government machinery. These measures seem to be working: inequality in Bolivia, while still high, has started to decline, and extreme poverty is on a steep decline as well. The Gini coefficient, the standard measure of income inequality, fell by 15 per cent in Bolivia between 2001 and 2011.

Governments tend to look after their own, namely the groups close to the top of the wealth distribution

What matters is the combination of policies. Unless ethnic disadvantage is tackled explicitly, attempts to reduce poverty can fail. In Vietnam, for example, the expansion of infrastructure to rural and remote areas often had the effect of widening inequalities within those areas, as the majority Kinh households were better able to take advantage of the new opportunities offered by roads or irrigation, while minorities found themselves falling further behind. Simply taxing and spending wasn’t enough. More specific policies were needed.

So that’s the first major benefit of this bottom-up perspective on inequality: it is very practical. If we ask which groups are getting left behind, we suddenly find ourselves with an agenda for effective action against poverty. A second benefit also becomes clear: once we know which groups are impoverished and excluded, we can often get a better sense of the political context that explains both action and inaction. Ethnic minority groups such as the Tuareg in Burkina Faso usually have little power and influence. Governments tend to look after their own, namely the groups close to the top of the wealth distribution. It is common to find that disadvantaged groups are actively excluded from power, in the name of prejudice, political expediency or some long-held grievance – the reasons vary. Once we understand what’s going on in each particular situation, we can try to change it.

That’s the upside. But this kind of analysis presents risks as well as rewards. Appeals to ethnicity or other group markers can be divisive, if not dangerous. Most of the wars in the world today take the form of clashes between ethnic or religious groups, and organisations that focus on such group characteristics very often turn out to be intent on violence. When we enter this territory, we have to tread carefully.

All the same, the Bolivian story should persuade us that the risk is worth running. In Bolivia it was an appeal to the most excluded groups that gave Morales his electoral victory and, with it, the power to tackle the problem. In Ethiopia in the early 1990s, the nation-building project that followed the civil war included a deliberate programme of education investment among excluded groups. Again, the reduction of group-based inequalities was a key part of the new government’s strategy for holding on to power. A clear view of the obstacles that trap the bottom end of the wealth distribution can deliver the political conditions for action, as well as the insight to show what that action should be.

Here, though, we hit a further problem. There is a pitiful lack of information about the key group-based inequalities that underlie poverty. International household survey programmes offer patchy and partial data on ethnicity – one important source of inequality, as the examples above demonstrate. But it is incredibly poor information; just enough to make some general points, but not enough, in most countries, to track changes over time, or to drill down into the combinations of ethnicity, geography and gender, for example, that are likely to act together in important ways to keep people poor.

We know a little more about education, and the fact that we do is thanks almost entirely to the team behind the Education For All global monitoring report, which maintains a database recording inequalities in that sector. A lot less is known about the causes of other key dimensions of poverty. We don’t have the same comprehensive database about health, for example, or income, or vulnerability to crime and violence. Even less is known about the factors that determine access to services that help people to change their situations: finance, transport, electricity, telecommunications. For many aspects of inequality, the information simply isn’t there, even for the most well-meaning governments.

the absurdities of boardroom pay and tax avoidance might prick our sense of fairness, but this has only a limited amount to offer the analysis of extreme poverty

What information there is tends to focus on a small number of inequalities, such as ethnicity or geography. These are highly important, but they can’t be the whole story. In most countries, to pick an especially glaring example, we know nothing at all about the number of children out of school who are physically disabled, or about rates of extreme poverty among the mentally ill, despite anecdotal evidence suggesting that such factors have a huge amount to do with discrimination and exclusion.

So let’s look again at our two inequality stories. The mainstream narrative – about the runaway incomes of the richest people in the richest countries, the absurdities of boardroom pay and tax avoidance and so on – might prick our sense of fairness, but it has only a limited amount to offer the analysis and treatment of extreme poverty. The second, lesser known, inequality story is about the things that keep people poor. This story offers fertile ground for the coalitions and policy agendas that can actually address both poverty and inequality.

These stories are, of course, linked. Concentrations of income and opportunity at the very top might well make progress at the very bottom harder, in some cases – for political, economic or social reasons. And more money, generated by taxing the super-rich, would give more options to those governments that do want to act.

But at present too much analysis and attention in the development sector is given to the first story. This has led to a situation where people want to believe that inequality is important, but they don’t quite know why. Answering that question requires us to grapple with the second type of inequality. And that, in turn, requires better information. At present, the empirical foundations of our inequality debates are far too weak. Perhaps that is the most basic inequality of all: between those of us who are counted, and those of us who are not.

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Claire Melamed

is the Director of the Growth, Poverty and Inequality programme at the Overseas Development Institute in London.

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