What Kind of Inequality Matters?

Thomas Piketty’s book, Capital in the Twenty-First Century, a thorough analysis of the causes and effects of inequality, recently became an international best-seller. It’s not often that thousand page economic treatises attract popular attention, so clearly there’s something important to discuss here. Looking at some of the data on inequality, it’s not hard to see why many people are concerned. Here’s a chart showing the share of income held by the top 10% in the United States since 1910:

Notice where the two peaks occur – 1929 and 2009. I seem to recall something important happening in each of those years. Whether inequality was a symptom or a cause of the broader problems that led to the Great Depression and the Great Recession is an interesting question and definitely deserves scrutiny. For the purposes of this post, however, I want to address a simpler topic. Should we care about inequality on its own? And, more specifically, what kind of inequality should we care about?

For the first question, let’s do a simple thought experiment. You can choose to live in one of two societies. In Society A, everybody makes $50,000 per year no matter what their profession is. LeBron James and a janitor get paid the same amount. In Society B, average income is the same $50,000 per year, but it is now dispersed, so that some people earn less than average and some earn far more. Now assume that you are guaranteed to begin at average income (to avoid questions of risk aversion). Which society would you rather live in?

The answer to the hypothetical depends in part on whether you care about absolute or relative income. Does it matter if you are rich, or does it only matter if you are richer than others? In Society A everybody is on the same level, which might seem to be an appealing feature.

Except as soon as we start to think a bit harder, we realize that people in Society A aren’t equal at all. At least to some extent, differences in income do come from differences in effort. Some people work harder than others. Should people get paid the same regardless of effort?

Of course, this reasoning attacks a bit of a straw man. Hardly anybody would argue for full equality of income. But that doesn’t mean that there aren’t some situations where reducing income inequality could be helpful. I don’t believe in free will, which means that I think that where you are today is determined by circumstances you had no control over. But even with free will, it’s impossible to deny that some people are luckier than others. Some people are born into families with higher incomes or better connections. Some people are just smarter, or more talented. Two people can put in the same amount of effort and come out with wildly different outcomes. Isn’t there some justification for correcting these kinds of inequalities?

Now we need to bring in the second question: what kind of inequality matters? To this point, I have focused entirely on income inequality, but money is only as good as what you can buy with it. Somebody who earns $1,000,000 per year but saves $950,000 is no better off than someone who earns $50,000 per year (until they start spending those savings of course). We also need to consider a dynamic component to inequality. The chart above shows only a snapshot of inequality at one point in time, but there is large variation in earnings over a person’s lifetime. So a better measure of the kind of inequality that actually matters would be total lifetime consumption inequality (due to measurement difficulties, the question of whether consumption and income inequality move together is still under debate – see a nice survey here).

But we’re still not quite there. Why do we consume anything? Presumably because it makes us happy, or, in the words of an economist, because it gives us utility. Simply giving people more stuff might not actually help them at all unless it’s stuff they actually want. So shouldn’t we actually care about total lifetime utility? And as soon as we jump into the world of utility, the problem gets much more difficult.

Consider an extremely wealthy person. Incredibly talented and smart, he excelled in school, founded a business, and became one of the most successful CEOs in the world. He has a beautiful house, ten expensive cars, flat screen TVs, season tickets to the Patriots. He can buy anything you could ever want. Except he works all the time, hates his job, and has no time for his family or friends. Despite his money, despite his consumption, he is miserable.

Another individual earns far less. She isn’t poor, but she earns right around median income. She doesn’t have a luxurious life, but she can afford the basics. More importantly, she’s happy. She has a loving family, great friends, a job she likes. Would she be happier with more income? Probably. But she doesn’t need luxuries to live a good life.

How do we make this society more equal? Simply looking at income would suggest a transfer from the wealthy man to the average income woman. This transfer would of course reduce income inequality, but it would increase utility inequality. The woman is already pretty happy and the man is not. Taking money from him and giving it to her would only increase the happiness gap. Is this outcome desirable? I don’t think so.

Then maybe we should try to minimize utility inequality. But how? Taking money from the woman would probably reduce the woman’s utility and eventually it would be as low as the man’s, but giving it to the man would probably do little to increase the man’s utility unless he takes comfort in the fact that others are as miserable as he is. The woman’s happiness comes from pieces of her life that can’t be transferred to others. Despite being born with all the skills necessary to succeed, the man would likely view the woman as the more fortunate one.

In general, trying to equalize utility gives some strange implications. Let give a few more examples.

Two people work in the exact same job and get paid the same wage. Seems perfectly fair. But what if one of them enjoys working and the other hates it? In dollars per hour, they are equal. In utility per hour, one receives more than the other. Reducing utility inequality would require that people who enjoy their jobs be paid less for the same work.

Some people prefer living in cities while others would prefer to live in smaller towns. Houses in cities are usually much more expensive, which means to achieve the same utility, a city lover will have to pay far more. In this case, income equality greatly benefits people who hate cities. Utility equality would suggest transfers from people who love rural areas to those who love cities.

Consumption equality could also generate large utility inequality. If one person places a lot of meaning on material goods while another values other aspects of their life, they would need different levels of consumption in order to achieve the same utility. Should we give more to the materialist than the ascetic simply because giving to the latter wouldn’t help them anyway?

And even these examples ignore the largest problem with trying to achieve equality in utility – it’s difficult to measure and impossible to compare across individuals. I have trouble defining my own preferences and determining what makes me the happiest, I certainly don’t trust others to do that for me.

So utility equality is probably not an option even if it were desirable. But income equality almost certainly worsens the problem of utility inequality. The people who make a lot of money are much more likely to also be people who place a high value on money. Those who earn less are more likely to enjoy a simpler life. In fact, there is little evidence that the rich are any happier than the rest of us. Taking their money makes them even worse off while helping those who are already pretty happy despite their relatively low income. The happy get happier while the miserable get more miserable.

Notice that I have deliberately avoided using examples with truly poor people. I can certainly see an argument for redistributing income to the poorest. Nobody should have to live at subsistence levels if they are willing to work. But being concerned about poverty and being concerned about inequality are not the same. It is possible for a society to have zero poor people and still be incredibly unequal and also possible to be almost perfectly equal with everybody poor (as it was for most of the history of human existence).

Have we gotten any closer to answering the original question? What kind of inequality should we care about? If you’ve made it this far, it should be clear that there isn’t an easy answer. We often use the term “less fortunate” as a euphemism for poor people and that almost exclusively refers to poverty in a monetary context. We view income as if it came from a lottery and then aim to use redistribution to correct for discrepancies. Why is that? Aren’t people that can be happy despite low income really the most fortunate? Isn’t money just one of many factors that matter for a person’s happiness? And aren’t many of these other factors difficult to measure and even more difficult to redistribute?

If we answer yes to the above questions, reducing the kind of inequality we care about becomes a much harder task. Can we really correct the deeper inequalities that arise due to people’s preferences and talents – some of which will lead to higher incomes and some not? Or should we accept that inequality is an essential part of society, accept that treating everyone equally necessarily produces inequality in outcomes, that differences in wealth don’t necessarily lead to differences in happiness, and that correcting differences in happiness is almost impossible?

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