Thursday, September 11, 2008

Does Economic Inequality Matter?

By Christopher Espinal

Seriously, think about that question and think about it good! Does it matter that 20% of the population owns 80% of production? Does it matter that some people make 20 times
more than you do per year?

There are several ways we can go about this question.

Preferences and Relative Utilities

Firstly, do humans make different choices? I suppose they do - each individual has a different preference. Some people like taking care of children and other people appreciate building businesses and making millions as the product.

But the concept of preferences goes a bit deeper. If we think about preferences in terms of a utility function as in economics we will probably find different rates of diminishing marginal utility of increases in income for different individuals. Some people probably prefer making
40,000 per year because after that amount they would rather consume more of other goods like leisure. This is what causes a backwards bending labor supply curve.

However, for the likes of Warren Buffet, he inherently enjoys watching his investments grow into something enormous. Thus, he has a different rate of diminishing marginal utility of income for marginal increases in income over time. This shows that people have different "consumption bundles" that make them happy.

Hopefully, you can see that happiness doesn't mean more money. The folks, who normally complain about Corporate Executives making more money "despite the 'stagnation' of the everyday worker's income," often lose sight of their main purpose for happily accepting lower paying jobs: more money doesn't equate happiness with a loving family and great friends.

So why do they complain about the rich? From my experience with speaking to people who buy into the anti-rich arguments, I often conclude they despise people who have more "success" (whatever that means), they want more without doing more, they idolize Europeans who work five hours a day, or they have too much time and want to argue about something.


Perhaps the same people who complain should try to figure out different ways to become more productive with their time. Well, what does it mean to be more productive? Suppose you have two people who have the same skills in repairing vehicles. The only difference is that person A
owns a repair shop and person B works for a repair shop. Person A has five people working in his shop and serves 30 people with car problems per day. Person B helps serve 10 per day. Who's more productive: the shop owner or the employee? Obviously, the one who can serve more people within any given time: the shop owner.

Let me give you another everyday example. Suppose person A owns a burger franchise and person B owns a burger shop. Person A "Serves a Million Smiles a Day" while person B serves only 100 people per day. Who's more productive? Obviously, the franchise owner, but everyone seems to hate this person because he or she makes more money.

The Scarcity of Skills

We can also compare employees to understand the reasons behind income differentials. Let us take the classic example: a CEO and an office manager (the person more likely to complain). If we believe in supply and demand models for markets, let us think about the number of people capable of running a multinational corporation like UBS and the number of people capable of doing basic office tasks. Is there a greater supply of competent CEOs or competent office
managers? I bet there are probably a couple thousand people in the world capable of running UBS and a couple hundred million people in the world capable of organizing an office. I can probably see why CEOs of these huge corporations make millions.

Does this mean that the number of CEOs will remain small? If more people in the world become educated, develop superior management skills, and decide to enjoy managing billion dollar projects, the competitive pressures in the "CEO Market" will push down on salaries and payouts of that magnitude. In other words, if more people become as productive as our current crop of CEOs that market mayexperience a downward pressure on salaries and payouts.

And your Point is?

These angles of looking at this situation have something in common. None imply that one person is bound to be worse off simply because one person makes 20 times more than another person. Your skill sets are matched up with everyone else on the labor market in your sector. If your employer decides to cut your pay, it's because there exists better alternatives that cost less to the profit maximizing business.

The labor market does what every other market does best: it allocates scarce resources on the pricing system. Unless these rich and powerful people engage in rent-seeking by buying out politicians to protect their enterprises, then one mustn't fret over other people making more money. People should think about how to improve their human capital and productivity to make more money instead of blaming "more successful" individuals. Besides, if money doesn't matter in life, then why complain about other people who have lots of money?

Last but not least, people have a right to advocate fairness and redistribution of wealth, but often the critics of rich people convince themselves of things that just don't exist. Rich people are not necessarily out to make your life worse;it's actually those people who are competing for the same

Christopher Espinal is an economics student at the University of Chicago. He can be reached at

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