This article builds on the ground of free-market, market failure, and causes and consequences of income inequality (i.e. equality from economic perspective). I will discuss the downsides and upsides of the principal of equality, and at the end, I hope it will leave you with something to think about, at least, for another 4-5 minutes after having read the article.
Is Equality Justice?
You see, people often talk about how they want to promote equality within a society, that it is the ultimate goal we aspire, the goal that marks the attainment of the ideal society where there are no rich, no poor, and thus, no single person with the power to oppress the others, no one to impose their own judgement as the righteous ways of doing things. This very foundation of thinking gave birth to socialism and even its more extreme forms such as communism.
In this article, however, instead of focusing on dictatorship, a popular example derived from the regime mentioned, I want to turn your attention towards the economic side of the coin.
The flaw in such thinking is the fact that “equality demotes incentive” is not taken into account. Equality, whether it is about equality in the ownership of means of production or the actual outputs, does not allow personal interest and effort to yield suitable level of return to stimulate further production, expansion and innovation. Since there is not pure capitalism, even in the country considered the epitome of capitalism like the US, a rich person is taxed by a large proportion of his income. This is done so the government can redistribute the taxed money to public service, failing businesses or the unemployed portion of the population (to promote equality). Sadly, such method of income redistribution does not allow full ownership of a person’s earning from his strenuous exertion of his time, mental and physical energy, and capital. This is fine as of now, but in a way, too much suction of personal wealth, if overdone, will result in moral hazard for both ends, the takens and the takers. How?
On the recipient end, we might face with “free rider” problem. Income transferred to the unemployed might just be enough for them to survive without having to work at all, and when that happens, people might lose the incentive to seek jobs just to earn a little bit more than what they are receiving for free.
The takens or the rich might have less motivation to work harder, to produce as much as he can. Additionally, such restriction on ownership of resources will give birth to a new incentive, which is for people to try to avoid taxes.
But the problem does not end there. On many different levels, equality can produce other adverse effects. One of such effects is hampering “spillovers”.
Spillovers can be in different forms. The most obvious is wage paid to employees. Taxing can make it less likely for businesses/personal interests to expand that will also allow higher wages and greater well-being for the mass. The less obvious is probably technological spillover, and by “technological” spillovers, I don’t just mean iPhone and iPad. I mean machinery, agricultural methods, systematic management, philosophy, culture, ethics, etc. Too much tax to ensure equality can drain away resources that could have otherwise be allocated to more significant areas like development and research that will in the end results in immense spillovers for the society.
Furthermore, maybe ones that have not been received much attention are some of the economic impacts resulting from the lack of understanding of basic economic concepts such as the paradox of thrift (spending = earning), efficiency, economies of scale, multiplier effect, and so forth. Let me illustrate via a few examples.
Paradox of thrift simply states that the less you spend, the less you earn, and vice versa because when there is expense, there is income; when you spend a dollar, there is another person who earns a dollar. Moreover, from our understanding of multiplier, the 1 dollar can turn to 100 dollars using the magic of economics. An economy that is overzealous in it pursuit for equality can lead to less disposable income for everyone, rendering the process mentioned less effective. To gain an understanding of how that can happen, I encourage you to read my other article “Understanding Multiplier” via the link below:
Efficiency is can be either a direct and indirect result of incentive. An incentive can be in the form of more profit and less cost (thus, more profit, competitive power…). This incentive only arises in privately operated organizations, and the presence of such incentive in non-profit or governmental organizations is, if none at all, faint. The continuous effort to drive down cost, to raise profit, to have the edge in competition (which also encourage higher quality), and to survive in the fierce competition imposed by free market put great pressure on private organizations, forcing them to find ways to do things efficiently both in their operation and allocation of scarce resources. For this simple reason, most government’s traditional tasks, including various public services and development projects once done by the government, are now contracted out to private companies, giving birth to the term we so love: “Privatization”. For example, municipal trash collection, which used to be done by the governments, is now, in many countries, the job of private firms. So, not allowing incentive by imposing the principle of equality will divest the firms of the incentive they enjoy, and thus, reducing the motivation for them to operate efficiently and to compete.
When equality is practiced and pervasive, another implication is that firms are less likely and less willingly to expand and innovate. When people do not perceive additional gain from their additional effort, they simply don’t try any harder. Now you might say: “But what about social return? the prosperity of one’s society? Wouldn’t all the good citizens want that?” Let me tell you that, yes, that they desire. However, at the same time, people also question fairness when it comes to equality. Will you be able to work hard if what you achieve is to be shared among people who do not work as hard as you do? The thing is resentment at free-riders will cause the system driven by equality to fail. As a result, in such a system, businesses (if there is any at all) do not have the incentive to expand (increase their inputs), and when they do not expand, they cannot produce more to reach the pinnacle of production, mass production large enough that per unit cost can be reduced significantly resulting in cost reduction for the entire population when consuming such a product. I will explain more about economies of scale (internal and external ones) in later articles. In the meantime, you can google the term out and get some understanding of it.
So far, it seems equality loses, don’t you think? Can we lead an economy by not considering equality at all?
Like what I mentioned in my very first article, the study of Economics will eventually teach you about the flaws of Economics, and the need to explore a broader world of knowledge to compensate for what Economics fails to explain.
In Economics, I was taught mostly about how free market and capitalism is about equal chance of success, not equal level of success regardless of what you do, not central planning. This makes so much sense that I really wanted to believe in this system of governing resources. It makes so much sense that it initially narrows my view into thinking that equality is not the “thing”. After all, we should get what we work hard for given the equal chance we have to reach our goal (which is conforming to the principle of equity, but I am not going to use the term here for various reasons). I wouldn’t want the result from my hardwork to be shared among those who do nothing or not perform as good as I do. I work hard for it, I deserve it. People, who do nothing or slack off, should get less, if not nothing. That way of thinking, my friend, is false.
Sorry, let me rephrase it. What I want to say is “using that mindset to justify the need to deride the principle of equality is misleading.”
Equality is not always a bad thing. Think of it this way; ketchup is not good with cookies, but it is great with burgers.
Equality might not work well if we apply it as equal redistribution of returns, but what if the principle of equality is moderately applied at the start of businesses?
Let me illustrate this concept with a simple example. You have two persons, A and B, who are identical twins. Both have the same intelligence level, same education, same personality traits, and same level of physical endowment. The only difference is that A is adopted and raised by a rich family, and at the age of 20, A is entitled to a tremendous amount of wealth at A’s disposal to start any business as A pleases. B, on the other hand, is adopted and raised by a poor family. B has to start from scratch at his 20 when he wants to start his own business. Both, by laws, are given equal chance. All else constant, again, the only difference is the amount of wealth A and B have to kick start business. What do you think will be the outcome?
If all else constant as stated, A will end up with larger amount of wealth faster and is able to expand his business and accumulate much more wealth, giving him the edge in competition. Why? Because business is also about who gets there first. A, eventually, will also inherit more wealth from his rich family allowing him to do much better if compared to B (who will undergo much more financial stresses and challenges due to both internal and external factors).
Simple as it may sound, when you expand the scale of such an example, you will see a bigger picture. You will notice that as time goes by, inequality tends to manifest itself in the form of wealth concentration in the lineage of the richer few. This gives them the power to acquire political favors and manipulating the once exogenous variables to them (such as taxes, economic policies, and international trade, etc) to further increase their advantages in the business and political playing field.
As a result, this increasing income inequality can create a situation in which the majority of the population, who does not possess such amount of wealth, start to rely on the strength of number. This can lead to public discontent, political turmoil, social instability, insurrection, and the worst possible scenario, civil war and social collapse.
Note: The impact of inequality is probably even more severe in developing countries. For developed nations, the unfavorable impact might be mediated by strong and effective governance with solid rules and regulations.
This sounds too gloomy, and most people might simply dismiss this idea as simply fantasy of the naive mind. However, one cannot reject the possibility of such events.
Economic principles, thus, should be practiced with prudence, and they should be accompanied with equality of all citizens in terms of human rights, universal education, protection, legal obligation, etc. This is like going back to the topic about “Poverty”, about human capabilities. Capitalism and free-market will give everyone a shot at success, but a sick person, by pure logical reasoning, will still be less likely to achieve as much as the healthy ones can. Therefore, equality is to ensure a level playing field for everyone.
So this means that, a broad application of just a single principle in an economy will not yield the optimal outcome or total failure as some might expect. Since an economy, a society, a country comprises so many dimensions of many different types (social, economic, political, environmental, ethical, etc), we need to adopt the right practice adapted to a specific dimension. One-size-fits-all principle is to be avoided at all cost.
The simple truth is embedded within the idea of Equifinality, which basically accepts and states that there are different ways towards a goal. This implies that a different combination of different principles can be used to achieve a greater positive outcome. We can also conclude that by including a moderate degree of equality, one can reach an equilibrium state where social welfare is actually improved, not just some economic indicators such as GDP and unemployment rate.
Just something extra here. Truth be told, there are certain policies that hurt in the short-run, but yield tremendous returns in the longer run. So, I strongly encourage you, especially economists and econ students of all ages, shapes and sizes, to explore the vast universe of economics and start questioning the economic models and theories you have learnt (and find the optimal option) before applying them in work, in the real world.