The benefits of wealth inequality

Those on the Left tell us time and again that wealth inequality must be addressed. The fact is, wealth inequality works and we need it

Rags and riches: does it need 'fixing'?
Andrew Gibson
On 28 May 2014 17:16

Do you have a promising idea and want to turn it into a business venture? Every year, many thousands of British people do exactly that. It is possible to commercialise good ideas in part because the UK has inequality of wealth and associated capital accumulation.

You have an idea, but insufficient money to fund that idea. Banks, venture capitalists, parents, and others have money and want investment opportunities to make their assets grow.

Capital accumulation, together with free trade, specialisation, property rights and the rule of law explain why, for example, West Germany became richer materially and culturally than the former East Germany.

This is not “trickle down” economics: capitalism is a gusher of wealth and creativity. But the system is under critical scrutiny again, as evidenced by the interest provoked by the Thomas Piketty book, The Sunday Times Rich List, and the tax avoidance of various celebrities.

Below are some pointers to guide us through the debate.

When the Left talks about the “top 1 percent” of wealthy people, the aggregate figures conceal huge individual movements. The top 1 percent changes over time.

Plenty of people lose money, grow it only modestly, or indeed give it away. To achieve top 1 percent status you need to exercise sound judgement and stewardship. This involves placing capital where it will grow – with consequent if unintended benefits for society (tax receipts, jobs, innovation – the sort of positive “externalities” the Left often overlooks).

To talk about the “one percenters” getting richer over time is near meaningless: it is not the same set of people under analysis.

In addition, holders of considerable wealth include pension funds, insurance companies, charities and trusts. Their enrichment is welcome.

Inequality of income and wealth is a driver of growth. If the young, or investors, see people making large profits in app design, or green technologies, they will shift their careers or investments to those sectors. Income disparities are part of the price system and they are a form of free speech (“invest here!”).

Curbing the price and income mechanism, whether through restrictive practices or governmental control, is as detrimental to growth as curbing the exchange of scientific evidence or denying education to girls. Censorship is damaging, be it censorship of ideas or prices.    

And such growth matters. If you are dirt poor, and many people in the world remain desperately poor, it is absolute income that is all important (food, clothing, access to education) not relative income or wealth (“don’t worry, we are broke too”). It is in the interest of the poor that we achieve high growth, and that is capitalism’s forte, downturns notwithstanding.

Capital accumulation also fosters cultural diversity. The more people who have wealth, the more sources of funding there are for religious or cultural projects, for example. Private individuals or institutions can properly fund experimentation where Governments fear to tread. Science, art, political discourse and experimental lifestyles are never “settled” – humans are a resource and their fruit is innovation and progress. Private funding allows a plurality of ideas or lifestyles to compete.

But mild inequality is not enough to fund progress. I can afford theatre tickets but I cannot afford seed capital to fund a new production. So, inequality has to keep pace with rising incomes in order that Mrs Investor can fund Ms Entrepreneur through a period of zero income during the initial, non-revenue generating stages of a project.

Over time the investors’ resources ideally will keep pace with the cost of the entrepreneurs’ most basic needs, otherwise start-ups can’t happen.

Consider also the Left’s illogic. If the Beckhams left the UK, and took their taxable income and all their spending with them, the country would lose out. Support staff would be laid off, New Bond Street would lose sales, and so on. But we would be a more equal society, which the Left says is a good thing.

Similarly, if more successful people chose to live and work in Britain – like, say, Kevin Spacey – bringing with them their talent, spending power and jobs, this would make us a less equal society and so the Left would be upset.

These absurd positions derive from placing equality before absolute living standards.

Another wrongheaded complaint is that wealth inequality is growing except in abnormal periods such as world wars, decolonisation, and perhaps other major traumas such as great inflations or nationalisation programmes. This is akin to arguing that “inequality is growing, except when it is not growing”: a meaningless observation.

A holder of wealth can spend it now and enjoy himself, or he can defer gratification, put the money to work, and take his reward later. But investment over time involves risk – precisely the risks I have listed, wars and so on, plus the usual commercial risks of new competitors or product innovation.

Investors get a return for risk precisely because there is the real possibility of loss. It is not true that the “rich are getting richer” – it is the wise or lucky stewards of capital who are getting richer.   

Nor, when discussing inequalities of wealth, should Government transfers be excluded, be they financial payments such as pensions and social security, or services such as health and education. Similarly, wealth and income should be compared “after” tax has been paid. Otherwise, one would be bemoaning inequality while disregarding in advance the huge steps that are already taken to ameliorate it.

It cannot be denied that luck or fate can play a part in wealth distribution. Inheritance, the making of contacts, the asymmetry of information, all these help shuffle the deck of resources. And it is also true that most economic liberals would allow “some” state intervention to ensure that the less well off have a chance in life – a decent education and so on.

But the Left’s cure is often worse than the supposed problem. Allocating resources through the political market place does not have the track record of growth of the commercial market place. The reasons for that are two-fold: one loses the advantages of private wealth listed above, and under statism the attainment of political office invariably has a greater role in spending decisions than the attainment of financially sustainable growth.

Having a plurality of funding sources (many people and institutions with ready cash) is a prerequisite of growth and of cultural diversity, not a failing of capitalism.

Andrew Gibson is an occasional contributor to The Commentator  

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