What's So Bad About Income Inequality?
Business Journal

What's So Bad About Income Inequality?

Even in rich countries, it can have a dangerous influence on innovation, well-being, and GDP

The rich are getting richer, but the world is a healthier, wealthier, and safer place than it has been in the history of humanity. Why should it matter if a hedge fund manager just built a 50,000-square-foot house?

When we think about well-being, we can't just think about wealth.

It doesn't matter at all, says Angus Deaton, Ph.D., unless that enormous house renders someone else homeless. Expand that example to a global economic scale, and you arrive at one of the central issues of Deaton's new book, The Great Escape: Health, Wealth, and the Origins of Inequality.

Dr. Deaton is the Dwight D. Eisenhower Professor of International Affairs and Professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs and the Economics Department at Princeton University. He is also a Gallup senior scientist.

Millions of people worldwide have made the great escape from poverty and misery. But what if they're pulling up the ladder behind them, making it impossible for millions more to escape? If that is how the rich of the world make their great escape, it has dire economic, social, moral, and political implications, even for citizens of wealthy countries, as Dr. Deaton explains in this conversation.

Gallup Business Journal: In your book, you write that though inequality can encourage people to catch up with the wealthy, it can also prevent people from improving their lot. Why does that happen?

Angus Deaton, Ph.D.: It happens in different ways at different times. Right now in America, it's more valuable [economically] to graduate from college than it used to be, and that creates a big incentive for people to go to college. But it also widens inequality -- the people who go to college earn more than those who don't, which creates a bigger income gap.

That kind of inequality does incentivize people to go to college, and that seems terrific to me. But you may not want to go to college, or you may, by bad luck, have been sick when you were in third grade and missed a crucial arithmetic lesson, and you don't do as well in school after that. Some people will be left behind, and that is just too bad.

One interpretation of the Pareto Principle, which suggests that 20% of the people own 80% of the wealth, is that there's no point in being angry about that inequality. Maybe the 20% is doing better than you because they went to college and you didn't -- but that's not hurting you.

Dr. Deaton: I agree with the Pareto Principle, but you can be hurt by that kind of inequality, and that can happen in many different ways. If a bunch of people get extremely rich but nothing happens to your income, that's OK. But if they use their wealth to start buying the government, for instance, then it's not OK, because you don't get your share in the democracy anymore.

I'll give you an example from the U.S. right now. If you're a drug manufacturer and you come up with a blockbuster drug that does very well, eventually the patent runs out. Your business could let the patent run out and let the generics manufacture that drug, which is what's supposed to happen. But your company could also spend a lot of money lobbying Congress to get an extension of your patent. That's an example of blocking equality, and it hurts people. And economists have been very weak on that.

Like everyone, we economists specialize in what we do. So economists think we're the gods of income; we tend to think about well-being in terms of income, and we don't worry too much about the other things that contribute to well-being, such as health, education, or participating in a democratic society. But not having access to an important medicine doesn't show up as a share of GDP.

When we think about well-being, we can't just think about wealth. That's one of the things we've learned from the Gallup World Poll -- how important many other elements are to a person's satisfaction with his life.

Why has inequality in the U.S. grown so much since the 1970s?

Dr. Deaton: Many things went into this. Some of it is globalization; some of it is vast technological change, which has made it difficult for manufacturing workers in the U.S. to compete against less expensive -- and poorer -- workers elsewhere in the world. The returns to education have gone up. There's been a lot of innovation in the financial sector, which has been richly rewarded.

But other than manufacturing workers, has inequality harmed anyone else?

Dr. Deaton: It's not entirely clear that inequality is a good thing. Now, some people get very, very rich from doing things that benefit us all. And we tend to think that's a good thing. We're Americans; we don't believe in jealousy. We believe that Steve Jobs got rich by inventing gadgets that make our lives better. We don't begrudge that kind of wealth. But if someone invents a mortgage derivative that brings down the financial system and hundreds of thousands of people around the country are unemployed for the rest of their lives, that doesn't seem to be quite such a good thing.

Speaking of Steve Jobs, he was American. Richard Branson is English. It seems as if the great innovators and company builders are from richer countries. But countries like Afghanistan or Zimbabwe have smart, educated, ambitious people too. Why wasn't the iPhone or Virgin Airlines created there?

Dr. Deaton: I don't think anyone knows the answer for sure. Scholars write books with titles like The Mystery of Economic Growth trying to answer the question of why and where economic growth occurs. But let me give you a couple of possibilities. China has been growing very fast for a long time by doing what is known as "catch-up growth" -- they're not inventing new technologies, they are adapting knowledge to their circumstances and doing it incredibly well. Something like that has also happened in India.

Now, think about Zimbabwe for a minute. In Zimbabwe, wages are cheap, so you could set up a big factory there and capitalize on cheap labor, cheap land, cheap transportation, cheap everything. And it would be a disaster, because Zimbabwe has a corrupt, oppressive government, and nothing works. That's one of the reasons why Zimbabwe is so poor.

In other words, you could have a brilliant idea, but no way to commercialize it -- no way to build a business that improves your country's well-being?

Dr. Deaton: That's right. And that's one reason politics is important in poor countries and rich countries. But remember, this kind of inequality has happened in the past; there was a similar state of political and economic polarization during the Gilded Age. But it was undone in this instance by two world wars, and it can be undone again -- though without wars, one can hope -- through political action, for example. And politics is quite unpredictable. For people who don't like inequality and feel they're being drummed down by it, politics is a way to reverse it -- participating in the democratic process is a way to reverse it. Collective action changes things.

But collective action can take a long time.

Dr. Deaton: I'm not entirely sure that's fair. Some things can happen quickly if there's enough public interest. Once we started inoculating people against smallpox, people stopped dying of smallpox. So don't overlook the importance of public action to well-being.

-- Interviewed by Jennifer Robison

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