IF an economy's income distribution becomes more unequal, is that necessarily a social problem? Many people tend to think so, reflexively. And the issue has become a current concern in many countries, for example, China with its rural-urban income gap, and the US, with its so-called 1% against the rest. In Malaysia, the issue seems perennial, cast mainly in racial terms. Politicians tend to react by coercing income redistribution from the higher income group to the lower using the powers of government or by expanding the welfare state.
How should one think about the problem? Is the reflexive assumption correct — that income inequality is a problem? Should not one consider how the income pie was created before judging income inequality a problem? Consider this: Would you want more Steve Jobses and Bill Gateses in your economy even if their very high earnings would exacerbate income inequality? I venture most would likely welcome not one but a thousand Jobses or Gateses into their economy whatever the impact on inequality.
Why? Because Jobs and Gates create/innovate goods that the average person wants. Since no one forces us to buy an iPhone or iPad or Windows computer, these voluntary purchases with our hard-earned money must make us better off. For that reason, Jobs and Gates can be viewed as in effect serving humanity as they conduct their businesses.
The better their products, the more people will buy them, the better off these people will be and the higher their earnings. Win-win. Their high earnings are in fact a monotonic function of how well they have served humanity. A priori then, there is nothing inherently wrong with higher income inequality in a market economy based on individual liberty.
Let me extrapolate. I do not begrudge the owners of McDonald's or KFC franchises or the famous Penang char koay teow lady, all of whom earn very high incomes by being incredibly successful in serving us. Similarly, I do not begrudge successful corporations like Singapore Airlines or the Giant supermarket chain or the small grocery store owners who might become richer than average by being the middlemen because they make it convenient for us to get the products we want or need.
The better the services these middlemen provide, the better off we are, and the higher their incomes. Again, win-win. The high achievers and earners need not be Jobs or Gates, just people who have succeeded in serving us better. Thus, we discern a basic principle of the market economy — the only way to become rich is to serve the people better. The harder one works, the more innovative one is and the better one serves the people, the richer one will be. The rich and successful in a market economy do not owe us anything. They have already served us.
Since that is how the income pie is created in a market economy, income inequality is a priori not such a bad thing. In fact, the infinitesimal diversity of personality traits, skills and talents in society implies that income inequality cannot but be the norm, not the exception. You may now object: What if you have a thief who becomes rich by stealing from you or a pirate who amasses riches plundering in the high seas or a feudal lord who gets rich by forcing excessive taxes upon peasants?
Or in modern days, suppose you have someone who gets rich via corruption or political connections, who gets a monopoly right to sell a product or some special exemptions that disadvantage his competitors or who benefits from insider trading or manipulation of stock prices — in other words, crony capitalism where high incomes are derived from government favours and corruption. Or consider situations where people are rewarded because of skin colour, race or tribe or where a group becomes worse off because of government policy — as in China where there are restrictions on rural migration to the richer urban areas.
I would concede that in the above cases you would be right. Income inequality propagated by ill-gotten wealth through theft, force, corruption, crony capitalistic favours, discrimination or discriminatory government policies cannot be justified. It leads us perhaps to a more general, deeper principle we have yet to make explicit. A market economy can indeed be subverted by crony capitalistic forces and other political distortions, which then subvert a principle implicit in our earlier discussion — meritocratic fairness.
As mentioned, the magic of the market system is that one can only increase one's income relative to that of others through merit by serving others better. To increase incomes, the entrepreneur/innovator racks his brains to figure out what yet unknown service or product the rest of humanity might need or want; the small grocer or big chain tries to figure out where to locate to serve the most people and what products are most needed; and the hawkers try to figure out how to make better Hokkien mee or char koay teow. The list goes on. Meritocratic fairness is the animating principle underlying the market economy that makes income inequality a non-issue.
You may again object correctly that the perfect market system does not exist. However, understanding these principles empowers us to strive for the best. Historically, the greatest market-based meritocratic systems — probably Britain in its heyday (before it became a welfare state) and the US today — have been the most successful in terms of wealth and innovations.
In addition, better understanding can help us avoid wrong-headed policies. For instance, the antidote to the ill-gotten version of income inequality is not to punish success with coercive income redistribution or to expand the welfare state and dependency. That would be like shooting ourselves in the foot. The proper policies must attack the root of the problem — crony capitalistic forces and bad government policies that foster racial discrimination, dilute and mock societal standards of excellence for advancement, or shackle rural people from free movement.
Institutionalising meritocratic fairness while promoting individual liberty and free enterprise will enhance social mobility, which makes income inequality a non-issue.
Dr Lim Ewe Ghee (Yale University; University of California, Davis) was Senior Economist at the International Monetary Fund, Washington, DC before returning to Penang after 23 years. This story appeared in The Edge on Aug 6, 2012.