Economic Myths #13 – Wealth Inequality and “The 1%”

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The inequality of wealth and income has been in the news again lately. According to the Daily Telegraph, 1% of the world’s population will own half of its wealth by next year. The Executive Director of Oxfam, who provided the figure, said that “an explosion of inequality was holding back the fight against poverty”, asking the rhetorical question “do we really want to live in a world where 1% own more than the rest of us combined”?

The mainstream debate over this issue fails to understand the true nature of the problem. The pro-free market side are wont to point out that such inequality “doesn’t matter” and governments should not do anything to interfere with the progress of business. The likely call from the opposite side, however, is for increased taxation and redistribution and, indeed, Oxfam itself stressed the need for a greater crackdown on tax avoidance by large, multinational corporations. However, the reality is much more subtle than simply left vs. right and, indeed, the debate produces a false dichotomy between “pro-business” and “pro-government/anti-poverty”.

On the one hand, we can agree that wealth inequality does not, on its own, create any problems for the generation of wealth and the reduction of poverty. The common attitude towards the rich appears to assume that someone like Warren Buffett or Bill Gates has tens of billions of dollars lying around in a bank account for them to spend and enjoy. The reality is that these figures represent the value of capital goods – machines, tools, factories and so on – that are invested in producing goods and services that everyone wants to buy. If these resources are in the hands of just a few people – say, “the 1%” – who most accurately devote them to the most urgently desired needs of consumers, then there is nothing economically deleterious with wealth inequality. Indeed, wealth inequality, in this scenario, is exceedingly good as any attempt to reduce it would divert resources into the hands of those less capable of directing them to the ends that people desire, or into those who would consume them. It is capital investment – more capital invested in more production processes to churn out more products that people need – and not taxes and redistribution that solves the plight of poverty.

However, this scenario is conditional upon the crucial aspect that resources must be in the hands of those who are best suited to serving the needs of consumers. In other words, those who are rich must have become so by meeting those needs. However, it is patently obvious that the current ownership structure does not reflect the voluntary choices of consumers. Rather, it is the product of crony capitalism, of cheap printed money that is ploughed into malinvestments and of taxpayer funded bail outs when it all collapses. The growth in wealth inequality is due not to the fact that consumers are voluntarily choosing to place that wealth in the hands of a few select people; it is because the government is throwing cheap money at this tiny elite so they can steal all of the world’s assets.

What, then, is the solution to this problem? Taxation and redistribution would clearly compound the economic evils rather than solve them. And, in any case, in spite of the hullaballoo about tax avoidance, the rich will always be able to influence tax policy to their benefit and to arrange their affairs so as to avoid it as much as possible. Rather, what is needed is a wholesale withdrawal of government from either supporting or hindering anyone in the pursuit of gaining wealth. All wealth should be obtained through the voluntary nexus of serving the needs of consumers and everyone should gain their wealth through their abilities and not through their political connections. What might such a world look like? Would it encourage wealth inequality or would such inequality be unlikely? One the one hand, it is arguable that wealth would still be highly concentrated. Genuine entrepreneurship is a rare talent and is likely to always remain so. However, if that is the case it is also likely that those particular individuals who own the world’s resources will rotate relatively quickly, with the top dogs remaining on the pedestal for only a short time. Indeed one aspect of the current wealth divide that is ignored is whether the same people remain stuck within their wealth/income group or whether there is relatively fluid movement between the different groups. Successful entrepreneurs make their biggest successes when they are small, nimble and contrarian. Once they have achieved their wealth, however, and their enterprises have morphed into large, multinational companies, they become large, unwieldy, inefficient and complacent. A former rebel becomes a part of the establishment who then becomes vulnerable to the insights of later entrepreneurs. Part of this can perhaps be seen with the technology industry where no, single player has managed to dominate each successive era. Microsoft put a PC into everyone’s home in the 1980s-90s; Google was the number one in internet search; Facebook was on top with social networking; and we are now, seemingly, entering a fourth phase where Apple seems to dominate smartphone technology. No single outfit has been able to carry through its dominance from one era to the next. Corporate dynasties and everlasting companies controlling everything will certainly not be a feature of a genuinely free market. Even a stock investor such as Warren Buffett, who has profited from a great many businesses in numerous decades, would be unlikely to achieve the wealth that he has done. Buffett’s mantra of value investing relies upon the price of a stock to become undervalued relative to the underlying value of the business, and for the price to then reach parity with, or exceed, that value. But the large distortions in stock prices – both up and down – have been precisely because of central bank flooding the markets with cheap, freshly printed money that results in excessive booms and busts. It is unlikely that Buffett, in a genuine free market, would have been able to buy and sell at such favourable prices as he was able to do in recent decades. On the other hand, however, it is also possible that a free market would reduce wealth inequality. As wealth creation ensues and the standard of living rises, ordinary people will find themselves with increasing amounts of disposable income that they may decide to divert into saving rather than increased consumption. Such funds, through savings accounts and the bond market, may form the backbone of investment funds that are ploughed into productive use. Thus, ultimate ownership of wealth may be more diverse than it is at present. Either way, however, we can be sure that the resulting structure of production and ownership will be one that best serves the desires of consumers and changes and adapts as the tastes of consumers change. Ultimately, it will always be the everyday folk, through their purchasing habits, who decide on the level of wealth inequality – not governments and central banks handing out favours to their political cronies.

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The False Dilemma

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Current, conventional thinking about social, political and economic subjects typically narrows the options available to a set of policies advocated by two, may be three political parties or scarcely dissimilar ideologies. Consequently any genuine radical or lateral thinking about these topics is abandoned and it is assumed and accepted that the fundamental questions of the state, the government, and of tackling the biggest societal problems of the day are already settled. Seldom are alternatives to these entrenched matters – such as whether the state should have any positive role at all in anything – given the light of day, let alone the opportunity of being debated. This phenomenon, which presents a distinct challenge to libertarians, is known as the “false dilemma” – the illusion that the only choice is between a very constricted range of possible options, preserving the status quo in favour of the state and its cronies while at the same time bestowing the illusion of control on a gullible electorate.

In the UK the “false dilemma” is playing itself out in such a way as to completely obliterate one of the basic truths (understood by Austro-Libertarians) that all humans can flourish and co-exist peacefully. Those on the ideological right such as supporters of the Conservative Party believe that business should be helped in order to boost economic growth, while cuts should be made to welfare and to public services in order reduce the government “deficit” (a much overused term given that the overall debt and not the deficit is the real problem) and to slim down the cash cow that the benefits system has become to the allegedly lazy and unproductive. Those of the ideological left believe that a strong welfare state, heavy taxes on the wealthy and increased government spending are needed to end the scourge of poverty. Both of these ideologies contain kernels of truth and genuine, honourable concerns that make their particular preoccupations seem plausible. It is true, for instance, that business needs to flourish if there is to be any economic progress at all, and that government needs to reduce its profligate borrowing, taxing and wasting with all due haste. On the other hand, it does not seem fair that a society should allegedly produce vast wealth for a few while leaving others to languish in stagnating poverty, nor is it necessarily true that wealth creation is “top-down”. The continuing result of this for UK politics seems to be that political action is becoming a choice, or a very false dilemma, between two broadly defined groups of people in society – a choice between those who are “rich” and those who are “poor”.

This impression is exacerbated by the fact that the political parties whose rhetoric represents these ideologies never achieve their aims, or never really carry them out. “Austerity” is proving not to boost economic growth nor help the plight of the poor simply because government spending is not, in fact, decreasing. Bank bailouts and cartelisation of businesses will not do the same either as they simply perpetuate malinvestment and economic waste. They do, however, save the politically connected rich from the consequences of their actions while leaving everyone else to foot the bill. On the other side, increased government spending and a burgeoning welfare state only siphon funds from the productive sector to be consumed and wasted by government. Both sides, therefore, in failing to ever be able to achieve their stated aims provide plenty of ammunition for the opposition, ammunition that is fuelling this apparent basic choice between “rich” and “poor”.

If we are ever to have any hope of recovery from the current economic malaise we must seek for a repudiation of this false choice and a restoration of the understanding that both economically and ethically the rich and poor can prosper side by side. At the heart of the problem, the false axiom accepted by each ideology, is the notion that government must help somebody in order to create a better society. There is curious mixture of economic and ethical arguments that are used in order for each side to select whom government should help and to whom it should deny the same. Take, for example, the supporters of big business. They will say that it is right to use taxpayers’ money to bail out the banks in order to avoid a complete financial meltdown. Conveniently “their chums” in the city will reap fat rewards from doing so. But they then deny this very same method – the diversion of taxpayers’ money – to welfare programmes to help the poor because people should work for what they earn without leeching from the productive and the so-called “benefits scroungers” should get off their backsides and find a job. In other words they are using primarily economic arguments to justify bank bailouts while using ethical ones to deny welfare spending. Their “lefty” opponents will argue that throwing cash at the rich who made mistakes is unjust and that they should be left to foot the bill for their own mistakes. Yet they then state that welfare spending is needed to eliminate poverty and fuel growth from the “bottom up”. So they too, deny the flowing of taxpayer’s cash to certain groups based on ethical grounds but then promote it to others based on economic grounds. Each side, will of course, pepper their ethical arguments with economic ones and vice versa – the right, for example, will, as we have said, argue that welfare spending needs to be cut in order to reduce government outlays, and the left will argue that alleviating poverty is a just and noble cause. But the main thrust of each side’s opinion cannot be denied.

If we unscramble all of this and look at the ethical and economic arguments separately we will find that there are no grounds whatsoever for any state involvement. If it is unjust to violently confiscate tax revenue from innocent citizens to fund the lifestyle of bamboozling bankers then it is equally unjust to do the same to fund the lifestyles of those who are poorer. The difference is one of degree rather than of kind. Nobody, whether he is a prince or a pauper, a saint or a sadist, or a capitalist or a labourer has the right to wrestle away the property of other people for his own benefit. And from the economic side, bailing out bad business will simply perpetuate the moral hazards and malinvestments that need to be eliminated, while continuously funding the poor through welfare spending will only exacerbate poverty as it makes being poor relatively more attractive, reducing any incentive for people to do more to lift themselves out of that position, while squeezing the role of benevolence and charity for the genuinely needy. Furthermore, government would do a lot more for the poor if it stopped interfering in wealth creation in the first place with all of its burdensome laws and regulations that make the exercise impossible but for a few large and politically connected corporate favourites.

The real choice is not between “rich” and “poor”, “left” or “right”, “Conservative” or “Labour” “employer” and “employee”, and whatever other faux selection that the establishment throws at us. The real choice we have to face is, on the one hand, whether we want to continue with a political and economic system that, whomever’s interests the particular delegates of the day purport to promote, will only result in a parasitic existence for the politically connected at the expense of the stagnation of the standard of living for the rest of us. Or, on the other hand, we could choose a system where nobody has the violently enforceable right to live at the expense of everyone else and that everyone is free to trade and produce whatever he wants with his property, a system that will raise the standard of living for everyone and not just a select few. Only by considering radical options and overcoming the assumption and acceptance that the fundamentals of our society are beyond debate can we hope to build a world that is both truly just and economically prosperous.

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The Limits of Libertarianism

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A distinct disadvantage of advocating a libertarian society as opposed to some sort of collective is that libertarians seldom win the emotional battle when pitted against competing ideologies. Democratic socialists and redistributionists can effectively wear their bleeding hearts on their sleeves, forever waxing lyrical about their concern for the poor, the sick, the elderly, and which ever other group appears to be in need of pitiful platitudes at this particular time. Libertarians, on the other hand, in calling for the right of every person to own his/her income, appear to advocate nothing more than greed and selfishness, the slippery slope to the disintegration of society as we each ferret ourselves away in an increasingly atomised existence.

This is a misunderstanding that is common not only among the opponents of libertarianism but also among libertarians themselves and it is high time that the latter stood up for themselves and realised how to counter these straw man attacks. Libertarianism is not and never has pretended to be a complete philosophy of how a given person should live his or her life. It is only states that each person should be given the freedom to choose what he does with his person or property. It does not mean that because an individual should have such a choice that he should keep his person and property for himself. One of the options is that he could, for example, give some of his money to the poor. It is, therefore, quite open to and consistent for the libertarian to state that a person should do X, Y or Z but that such a person should not be forced to do so. Simply because a person cannot be forced to do something does not mean that libertarians do not, individually, believe that people are subject to other moral obligations; it’s just that libertarianism itself stops short of discussing them. So as long as these obligations are not violently enforced then they are compatible with libertarianism, but do not form part of it.

Collectivism, however, is markedly different. For when collectives posit a certain forced redistribution of wealth and income amongst society this is usually based on an all-encompassing moral and political theory. So, for example, a collectivist might state not only that a person should donate a portion of his income to the poor but that also he should be forced to do so. It is this aspect that makes collectivists look more “caring” and “sensitive” to the needy – the fact that they are prepared to “enforce” their moral outlook seems to show they mean business. Libertarians, in contrast, come across as cold and uncaring, relying only on a vaguely defined notion of voluntary charity to take care of society’s ills.

There are three possible ways in which this may be countered. The first is to admit that libertarians are somewhat guilty of contributing to this view as few have developed an additional moral philosophy on top of their libertarian beliefs (although we can perhaps excuse ourselves given that the weight of government violence and intervention in today’s world is more than enough to be getting on with). But we must either turn our attention to developing our own, private, moral philosophies on which our passion for liberty forms the core, or, at the very least, we must be prepared to acknowledge the problem and explain the compatibility of any moral philosophy with libertarianism as long as it permits the individual to choose.

Secondly, contrary to popular opinion, the history of ideas has seldom been one of “liberty” vs. “collectivism”; rather it has been that of one version of collectivism versus another. As Mises pointed out, everyone has their own idea as to how they think goods and resources should be distributed throughout society: “In the eyes of Stalin, the Mensheviks and the Trotskyites are not socialists but traitors, and vice versa. The Marxians call the Nazis supporters of capitalism; the Nazis call the Marxians suporters of Jewish capital. If a man says socialism, or planning, he always has in view his own brand of socialism, his own plan. This planning does not in fact mean preparedness to coöperate peacefully. It means conflict”. (Omnipotent Government, p. 253). By pointing out this fact libertarians can demonstrate how, in a free world, everyone can pursue, in harmony, the ends that he believes are morally right with his own person and property, whereas to do so violently would just mean endless conflict with everyone else who happens not to share your view.

Thirdly, if a collectivist claims to care about the needy in society then we are entitled to ask why he favours a system that is almost guaranteed to make them worse off and why they oppose the very system – capitalism and freedom – that has been responsible for the most enormous increase in the standard of living in the whole of human history. Poverty is the state of nature of humans in the world; it is their ingenuity that has flourished through freedom that has allowed them to harness the powers of nature and increase the amount of wealth and satisfaction that we gain from them. If we compare the condition of human existence in 1800 (where 85% of the world’s population was living on $1 a day) to that of today (down to 20%) then we can see that freedom has been exceedingly good to the poor. Perhaps smart libertarians, accused of ignoring the plight of the needy, should raise this point and query whether, in fact, it is their ideological opponents who are really the ones who don’t care?

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What about the Poor?!

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When debating the virtues of a capitalist or libertarian society, one can extol the benefits of private property, free exchange and non-violence. Most of the nagging questions – “how would police work in a free society?”; “how would we regulate unscrupulous companies?”; or the now-clichéd classic “who would build the roads?!” – can be dealt with fairly straightforwardly and it is not difficult to show how such a society would deal with these matters in a vastly superior way to one that is imbibed with statism.

However, there is one question that always presents a seemingly insurmountable difficulty – what would happen to the poor? By this, we do not mean the accusations of a free economy being “sink or swim” or “dog eat dog” which can also be disposed of fairly easily. What we mean is the fact that a free world would have no “official” institution or “social safety net” to help those who were genuinely less fortunate. A libertarian might mumble a few words about the importance of charity but with an outright declaration by one’s opponent that such a system is necessary, one may be tempted to concede that this is the Achilles’ heel of a libertarian society1.

It is high time that libertarians took the offensive against such a criticism and turn this apparent weakness into an advantage. In the first place, the question depends very much on how we are defining “the poor” – absolutely or relatively. In an absolute sense, the first hurdle to jump over is the criticism that capitalism is actually the cause of poverty. This is nonsense. Poverty is the state of humans in nature. When the first person walked the earth the only tools he had available were his bare hands. There is no “capitalist” system to speak of and his lack of food, shelter, clothing, and anything even remotely enjoyable in life is because nature dealt him this hand. Capitalism, that is, the accumulation of capital, is what moved him away from this state of nature and allowed him to enjoy hitherto unimaginable riches. On the eve of the industrial revolution, 85 percent of the world’s population survived on less than a dollar a day in today’s money. That figure is now down to 20 percent2. Blaming capitalism for the remaining poverty and “inequality” is like blaming a treatment for cancer for “only” curing 80 percent of cancer cases. The conclusion one would draw from such statistics is not that the treatment should be abandoned but rather that it should be extended to the remaining 20 percent as quickly as possible! One answer to our problem of what to do about the poor is, therefore, to say that capitalism will simply make poverty irrelevant, an evil vanquished and consigned to the pages of history books. And it is precisely those areas of the world that do not possess the institutions necessary for a functioning of capitalism – strong private property rights and the rule of law – that are still mired in poverty. Furthermore, those countries that have experimented with socialism experienced nothing but stagnation, decay, environmental destruction and a permanently low standard of living. So for someone who questions what a capitalist system would do about the poor it is incumbent on that person to explain why he favours a system that would keep the poor very much in poverty.

The more popular argument against capitalism, however, is that it causes relative poverty – that some people get ahead while others are left behind to languish. Apart from acknowledging what we just mentioned – that there are areas of the world where a capitalist system simply cannot flourish – the primary reason regarding one’s own political system is that everything in a given Western country is mind-numbingly centrist. In the UK political division was formerly split between the Tories – representing the preservation of the superiority of the aristocratic, landholding caste – and the Liberals which were born out of the enlightenment. When the liberal philosophy succumbed to socialism after the World War I, the latter marked a seemingly distinct contrast between the interests of businessmen and “capitalists” on the one hand and that of the working class on the other. This continued for the next seventy years until the collapse of socialism in Russia and Eastern Europe left socialism as an empty and unworkable philosophy. Beginning with the Thatcher era and culminating in the Blair Government, the ideological shift was to the centre – that, not any more was it “the workers” vs. “the bosses” but, rather, Government would allow business to pursue profit while preserving the welfare state and the nationalisation of certain industries such as healthcare. What has resulted, therefore, is a very rich strata of society and a very poor strata of society both supported by the Government, and ultimately all paid for by the middle classes. It is this “corporatist, welfare state” that has caused the bifurcation of wealth rather than any vestige of that system that could be referred to as capitalist. We have already seen in the 2007-8 financial crisis how the rich – usually connected with a financial system propped up by the legalised fraud of central banking and fractional reserve banking – rather than suffering losses are bailed out when they make huge entrepreneurial errors. Their gold-plated situation is one of “profit & profit” rather “profit & loss”, increasing the propensity to gamble recklessly and plough scarce resources into loss-making ventures. At the opposite end of the scale the poor are also bailed out of their situation, increasing the attractiveness of unemployment, consumption over saving, and the dissolution of traditional institutions such as family and friendship. The net result of all of this is a permanent rich and a permanent poor, all supported by the state and, ultimately, the middle earners who are not “too big to fail” but also not poor enough to receive government welfare handouts. This is the real cause of the inequality between rich and poor in the Western world today – that the gap is mandated by the extant political system – and not by capitalism.

A capitalist system, in contrast, would be strikingly different. In the first place, the rich can only stay rich by continuing to devote the scarce capital goods to the ends that are most urgently desired by consumers. No bailouts, no socialisation of losses. But also the whole purpose of a capitalist system is mass production for the masses. It is not a system of trading phantom assets denominated in paper money. It is this mass production that extends what were once the luxuries of the rich to the rest of society. In the pre-capitalist era, a rich man may have had a horse and carriage and the poorer man may have had nothing and would have had to walk. Today, the difference is that the rich man may have a Ferrari and the poorer man a VW Polo. But at least now they both have a car. Whereas before the difference was one of how quickly it would take one from get from A to B, the remaining difference is simply one of comfort and style. The relative gap has, therefore, narrowed. All around us we see a shortening of the time from the development of a luxury item to its dissemination amongst the wider population. It took several decades from the invention of the computer before every house and office had a PC; yet the Smartphone revolution has taken only a few years. As capital becomes more ubiquitous, therefore, the result is a practical narrowing of the gap between rich and poor.

Having pretty much explained why the poor would be far better off under a capitalist system than under a collectivist one, what of the fact that there is no formal institution for helping the poor? Here, people too often jump to the virtues of the welfare state while undermining those of a world without it. As we noted above it is precisely because there is a welfare state that the relative importance of other institutions such family, friendship and the local community become less important. After all who needs to rely on friends to help you out in your hour of need when the state will do it all instead? Without the state to bail one out however, such institutions are likely to flourish. The irony is that, under a capitalist system, the very selflessness and altruism that its critics say is destroyed by capitalism would in fact receive an almighty boost! The capitalist system is simply one of human co-operation; its just that this co-operation is voluntary rather than enforced. People do not simply stop co-operating because they aren’t forced and when the relationship is voluntary it leads to human beings that are more understanding, caring and friendly towards their social counterparts rather than the bitterness, hatred and resentment that results from mere force.

Critics of capitalism should therefore be met head on with the facts that a free economy a) reduces absolute poverty by allowing production for the masses to be unleashed, b) reduces relative poverty by permitting luxury items and innovations to be mass produced, and c) encourages family, friendships, empathy and understanding between human beings who will be more likely to help each other out when they are in genuine need. Given all of that, it becomes incumbent upon the statist to explain why he favours a system that preserves poverty and creates a society of selfish, bitter and uncaring individuals.

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1A curious aspect of political debates where liberty is pitted against some form of collective is that liberty is subject to a paralysing degree scrutiny to which its opposing philosophy is not. If libertarianism shows a single morsel of uncertainty when answering how it would solve a particular problem it is declared to be unworkable and impractical, regardless of how many other areas in which it is shown to be beneficial. Yet people happily support and vote for political parties in spite of disagreements with particular aspects of their manifestos.

2Tom G Palmer, Interview with an Entrepreneur Featuring John Mackey in Tom G Palmer (ed.), The Morality of Capitalism, p. 26