Inequality doesn't cause social disruption, undeserved riches do

Not long now, the statistics say, and we'll be back to a turn of the century ratio between the incomes of the richest and those of the poorest.

Our Ginicoefficient (which measures income inequality) is already at its highest (ie worst) level for 50 years. You might think that this matters. But not everyone does.

After all, they say, if we commit to feeding, housing, clothing and educating everyone in a reasonable way, why should inequality which appears to be the natural result of democratic capitalism be perceived as a huge problem? After all, the economic pie is not a set size, and many of the very rich are the ones that do the work that increases its size. That's good for everyone.

Start your trial of MoneyWeek today

Get unparalleled financial insight, analysis and expert opinion you can profit from.

Start your trial

Sign up for MoneyWeek’s free twice-daily newsletter.

Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.

Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.

Sign up

The Economist points out that many years ago Tony Blair claimed that it made no odds to him how much football players and the like got paid as long as he could use the proceeds of their tax take to cut child poverty. His fellow cabinet ministers went out of their way to agree; and back in their days, Margaret Thatcher and Ronald Reagan clearly did too.

But while this sort of makes sense, it isn't the whole story. Instead it seems that what matters is not inequality, but the type of inequality.

This article from January sums up much of the research on the matter.

It notes that, despite what you might think, there isn't that much evidence that income inequality in itself causes social disruption. There is some evidence that it can cause stress and health problems, but not that much (you can relate stress of this kind to anything to do with status differences rather than just income differences).

However, there is some good evidence that it can cause financial disruption: Raghuram Rajan, who spoke at the CFA conference I attended in Edinburgh last month, suggests that inequality was one of the causes of the financial crisis in the US.

The wealth of the rich was soaring, but the real incomes of everyone else were static. People responded by borrowing vast amounts of money (usually against their houses) to maintain or grow their standards of living. See Rajan's book Faultlines for more on this.

The interesting bit about his story, though, is that it isn't actually just about inequality. It's about a large section of society getting poorer, not richer.

And this is the dynamic that seems to be important when it comes to trying to figure out if inequality matters. Happiness studies suggest that one of the things that make us relatively content is the expectation of a better future.

So if the pie is growing and you know you have a chance of getting a little more of it soonish, inequality of income, while irritating, isn't that big a deal.

But if it isn't growing, or if it is and you know you are likely to get no more - or even less - it is a big deal. And if that is as a result of corruption or grotesque opportunity handicaps, it is a really big deal.

It is the changing dynamic around perceptions of the future that cause problems. So, in China people were prepared to work ludicrously long hours for little money as long as they felt it would lead to riches in the end. But today, with corruption thriving and the income gap between the richest and the poorest deciles of the population at 65 times (if you include unreported incomes which mainly accrue to the powerful - says Edward Chancellor of GMO writing in the FT) they aren't prepared to work for jam tomorrow anymore. Hence the huge rises in wages and the regular anti-corruption protests.

Much the same goes for the Middle East and North Africa. There, populations were prepared to put up with all sorts of dictatorial nonsense as long as life wasn't actually getting worse. But when food prices soared and it was getting worse, their patience with inequality and corruption appeared to run out (we'll be arguing about this for decades, I know, but that's the way it looks at the moment).

The fact is, corruption and unequal opportunity bother people in a way that deserved inequality does not.

Closer to home, note that you don't hear many people complaining that the likes of James Dyson and Luke Johnson should be taxed out of existence. That's because we know that it is fair that they get to be super-rich and because we know they are expanding the pie.

But you do hear a lot of people railing against the ludicrous way in which becoming a banker or a listed company CEO has become a route to independent wealth. That's because we all know that they are paid too much and it isn't fair. We know that the more pie they get, the less we get (as shareholders and as clients). And these days we know that while they are getting richer, most of us with our falling real incomes are getting poorer.

So while it may be true that inequality inside a generally fair society in which a rising tide is having a go at lifting all boats doesn't really matter, recent events suggest that the other kind does.

What this means is that we shouldn't bother with fighting inequality in the West just for the sake of it. But we should focus on preventing the unjustified rise of inequality, starting perhaps with the abnormal profits regularly made by our banks and the abnormal amounts of money paid out to their staff as a result.