Not All Inequality Is Created Equal

By Justin Callais. Excerpt:

"In a 2017 paper, my friend Vincent Geloso and Steven Horwitz drew an important distinction. They separated what they called “good” inequality from “bad” inequality; this distinction helps explain why you cannot just simply look at inequality on its own and expect to explain societal outcomes or prescriptions from it.

Good inequalities arise from individual choices and the rewards to skill and innovation. The Patrick Mahomes example earlier explains this. Also, the fortunes accumulated by genuinely innovative entrepreneurs reflect how much value they created for everyone else. Previous estimates found that innovators “capture” a negligible amount of the value that they create for others. The entrepreneur captures a tiny slice, and the remaining surplus and value go to the rest of society. Not a bad deal for us! As Vincent and the late-Steven note, policies trying to limit this type of inequality will inevitably make society worse off.

Bad inequalities, on the other hand, arise when government policy restricts options for many, especially those at the bottom, while providing even more opportunities for those at the top. Here are some simple examples. Zoning restrictions raise housing costs and trap less skilled and younger workers (without the financial capital to afford to move there) out of high-productivity cities. Ganong and Shoag estimated that this dynamic alone explains about 10% of the rise in U.S. inequality from 1980 to 2010. Occupational licensing, an area we focus on a lot here at Archbridge, erects expensive barriers to entry into industries that the credentialed already occupy. This harms low-income people to a greater extent, given that a fixed fee is a higher percentage of their income than for someone who is already relatively well off. Corporate subsidies and lobbying for regulations on new entrants entrench wealth for the well-off and politically connected. These are the types of “bad inequalities” that are worth pursuing fixes for.

There’s also a simple measurement issue. Take a simple example. If an immigrant moves from another country to the United States, they typically make much more than they did back home (if not, why would they move in the first place). However, on average, immigrants (at least at first) make less than the average income in the United States. By definition, that increases inequality, but few would argue that this is bad for the immigrant. The immigrants’ mobility and opportunities increased. This is one of the many reasons why I prefer measuring something closer to social or income mobility, as it better captures opportunities for individuals.

Other “measurement error” issues arise from aging populations. Thomas Lemieux estimates that about 75% of the increase in inequality can be explained by aging populations. People typically earn more the further along in their career they are; if societies get older on average (people living longer, fewer kids, etc), then simply inequality measures will naturally rise. And furthermore, much of the “not-measurable” skills (networking, social capital, etc) will only further conflate that.

This framing maps well to my recent piece on billionaires. Where markets reward value creation, ambitious people build companies. Where the state controls enough resources and regulatory leverage, ambitious people capture those instead.

Good inequality is the downstream result of productive entrepreneurship rewarded in competitive markets, while bad inequality is the result of unproductive entrepreneurship rewarded by political capital. The crucial insight from Baumol is that it is a story about institutions. Productive behavior and unproductive behavior respond to incentives, but they just operate in different institutional environments."