How to Think About Inequality

Inequality is an issue that’s particularly difficult to talk about within libertarian circles. The subject has been politicized, and most people have an opinion on whether inequality ought to be reduced or not. Libertarians dislike the topic because they believe, rightly, that to a great extent inequality is justified by the advantaged conferred by exploiting these inequalities. But, then they use this as an excuse to avoid the rest of the debate, arguing that whoever is still arguing about inequality is missing the most important point. The problem with this worldview is that it’s akin to plugging one’s ears and then yelling really loudly to avoid having to listen to uncomfortable ideas. It also condemns your knowledge to a certain lack of sophistication, because the truth is that comparative advantage explains only so much.

The case for inequality goes something as follows. Humans are born unequal: we have different preferences and abilities. By taking advantage of these differences, we construct a division of labor where the opportunity cost is the lowest. This is the basic concept of Ricardian comparative advantage. Differences in prices, in turn, are beneficial for two major reasons. The most often cited reason is to provide an incentive for more productive individuals to work as hard as what’s optimal. I actually think this way of thinking about it has its flaws. The more important reason to allow for heterogeneous and market-led prices is to allow them to better reflect differences in the value of the factors of production, including labor, so that the market can best allocate these resources. All of this leads to inequality, but at the same time it benefits society by allowing for much greater productivity.

Unless you reject comparative advantage, the logic of the case for inequality is sound. It’s also widely accepted, even by most economists who would like to reduce inequality. If you don’t believe me, you should read Joseph Stiglitz’ The Price of Inequality — Stiglitz’ views are relatively extreme, yet he still accepts the logic of comparative advantage and its implications. The problem is that differences in ability doesn’t explain all inequality. So, the “libertarian” (better said, the economic) case for inequality is trivial, which is why it seems nobody considers it. Everyone considers it, but it has been internalized to the extent that they don’t need to repeat it, especially if everyone already knows its truth.

The problem, for libertarians, is that going beyond this seems to require passing judgment on the desirability of inequality. But, avoiding the topic of inequality because of this seems like a complete non-sequitur. Whether something is “good” or “bad” is a normative statement. It’s a matter of opinion. Economists are in the business of making positive statements (except for those who make policy recommendations) — economics is a theoretical science.

How does an economist look at inequality, then? The economist is interested in explaining the world around her. This world includes inequality, and the subject has become more and more important (to people) over time. We know that a sizable chunk of it is caused by differences in abilities, and consequently differences in values and monetary payment. However, we also know that another sizable chunk of inequality is not explained for by comparative advantage. Therefore, it behooves economists to study what does explain the rest of inequality. For the free market economist, in particular, this subject is important, because either: (a) we need to develop alternative theories to combat bad ones; or (b) maybe some of the theories out there, that we disagree with, are correct and we need to change our worldview. If we don’t do this then we, in fact, have nothing to say about inequality, and worst of all we sound like broken records repeating the same ol’ fact (that everyone already knows) as if it were something new.

Neither is it outside of the economist’s — as a scientist — scope to make cost-benefit analyses. It requires a good amount of abstraction, which consequently leads to significant margins of error, but we can look at inequality as a cost. But, it’s a cost attached to “something” (e.g. comparative advantage) that also has benefits. In the case of differences in productivity, sure one outcome is inequality, but another is increased productivity. Most people accept exploiting comparative advantage as acceptable, because otherwise the division of labor would have never come into existence. But, other times inequality doesn’t pass the cost-benefit analysis. We get the cost of inequality with too little benefits, such as when it occurs as a result of rent-seeking or unconstrained (which is not necessarily the same thing as unregulated) financialization. Of course, looking at inequality as a cost is subjective, but the truth is that most people probably do consider inequality to be bad to one extent or another — few people oppose progressive tax schemes, for example.

It’s clear, to me at least, that tackling inequality as something that should be explained, to the extent that people can weigh the costs and benefits for themselves, is something economists ought to do, whether they’re anti- or pro-market. The alternative, sticking one’s head in the sand and repeating “comparative advantage!,” is unsophisticated, and is the product of digging one’s heels in the dirt just to avoid subjects which are uncomfortable because they carry a “progressive” stigma. This seems completely wrong to me because: (a) we condemn ourselves to ignorance (by not even caring about what explains inequality, apart from comparative advantage); and (b) we declare ourselves irrelevant in the positive debate, because we really have nothing new to offer. Besides, if you first consider the normative, rather than the positive, you’re probably conflating the two, and you’re forgetting the true purpose of economic analysis.

18 thoughts on “How to Think About Inequality

  1. JosephFetz

    “The economist is interested in explaining the world around her.”

    Where did that come from? Just curious.

    1. JCatalan

      A couple of years ago someone who had read my Mises articles suggested I make more of an effort to substitute “her/she” for “his/him,” and since men probably don’t care one way or the other it doesn’t hurt the please our other halves — although, I guess this outlook is sexist in its own way.

      1. James Paul Gonzales

        I wouldn’t worry about being gender neutral in your presentation, though it’s good you recognize a potential dilemma. Most economists probably aren’t interested in gender theory and feminism.

  2. Dan (DD5)

    Who is ignoring inequality? What are you talking about?

    Inequality is a condition without which no division of labor could arise. Mises in HA made this quite clear for example already in the beginning.

    Seems to me that you’re making a case out of nothing here. If we take your approach, we have to say that money is a problem. Money is, after all, what the special interests are after when they bribe the politicians. It’s money they’re after when they lobby for that tariff, or that regulation, or whatever…. seems to me that Austrians are ignoring the problem of money also.

    1. JCatalan

      I think you’ve missed the point. Btw, I don’t use the word “problem” to describe inequality in this post, but if I ever do it’s not in the normative sense, but in the sense of an issue that needs to be explained.

      Inequality is a condition without which no division of labor could
      arise. Mises in HA made this quite clear for example already in the

      Yea, I think I said three or four times in the post that everyone already knows this.

  3. Pingback: Advocates of Reason: 9 May 2013 | Economic Thought

  4. steve

    Economists have actually spent a lot of time lately discussing inequality outside of ability-endowment … Acemoglu, Autor, Card, Goldin, Lemieux, Katz, etc

  5. valueprax

    What if “economists” have said something about inequality, and what if they have said all there is to say, and you are just someone who doesn’t like that “that’s all there is to it”?

    Could that be a possibility?

    1. JCatalan

      That could be a possibility, but I don’t find it likely. But, it could be, and the economist who believes that would have to advance a convincing argument.

      1. valueprax

        What would that look like? What are your criteria for a convincing argument? Is it like a “I’ll know it when I see it” kind of thing, or is there some specific formula I could fit my idea into and present it to you such that you’d deterministically have to be convinced by it?

        1. JCatalan

          My criteria for a convincing argument is an argument that convinces me. That is, it makes sense to me and I can see its relevance. For example, you could offer a convincing argument as to why comparative advantage does explain all inequality. Or, you could convince me by showing me that my own explanations for “superfluous” inequality (I’ll define that as any inequality not caused by comparative advantage) are wrong. Admittedly, my own theories on superfluous inequality aren’t that well fleshed out, so it’s not as if I’ve necessarily provided a convincing case either. But, there has been a lot of work on rent-seeking, and we know rent-seeking can cause inequality by redistributing wealth through the use of force. And, I think there’s a strong case that the banking system, as it exists today, also is a large cause of inequality (for example, the banks issued a large number of mortgages to people who could only afford them if the value of their house rose or was maintained. If mortgage owners were required by law to repay the banks, then the banks’ wealth would be unaffected, but if the value of the house collapsed then we’d see a change in relative wealth — this is the case in Spain, for example).

          1. valueprax

            Right, so a “convincing argument” is one that “by definition” convinces you. That’s what I suggested. Which doesn’t help a person interested in communicating with you predict accurately in what ways they could shape their own communication to aid your ability to comprehend.

            Would you be willing to summarize the “main idea” of this article in one or two sentences? For example, if I “got it”, what did I get from your post? What new consideration do I walk away with, what core idea or relationship?

          2. JCatalan

            Any part of a debate is finding a way of convincing the other person. If there was some easy, straightforward formula to convincing people then there wouldn’t exist protracted debates. I’d summarize the article, but I feel that it wouldn’t be any clearer than the article itself.

          3. valueprax

            Here is my understanding of what you wrote, can you tell me if I got your message?

            P1: Some libertarians have an unsophisticated view of inequality as a social issue because they think it’s all about comparative advantage when it’s not.

            P2: Crude libertarians focus on the motivation inequality gives to individuals to perform optimally; my sophisticated take is that inequality communicates allocation information through prices.

            P3: Everyone seems to accept the law of comparative advantage and this is not where the controversy around inequality comes from as even people against inequality accept comparative advantage.

            P4: Economics is about describing reality, not passing judgment and this fact presents a problem for libertarians in discussing inequality.

            P5: A lot of inequality is caused by innate differences in ability, but the rest is explained by other social factors and it is the economist’s job to investigate these; if libertarians don’t change their mind when they’re wrong, no one will take them seriously.

            P6: Economists can and should make cost-benefit analyses but they need to understand that costs and benefits are subjective and people might see it differently than they do.

            P7: Libertarians should discuss inequality lest they be deemed irrelevant simpletons.

            It’s hard to follow this post, like so many others, because it’s not clear who you’re addressing and what inspired you to address them. I THINK you’re aiming this at “libertarians”, and I THINK it’s because you have some perception that “libertarians” refuse to talk about inequality. But it’s hard to know if that’s really what you’re trying to accomplish because “libertarians” do address “inequality” in their literature. They don’t obsess about it the way, say, a progressive might, because they typically don’t pass a normative judgment (right/wrong) on it, they just describe where it comes from (innate abilities and social institutions) and what its effects are.

            I think then what you’re really trying to say here is that “libertarians” should work on more convincing arguments? And they should be aware that not everyone who isn’t a libertarian will see their arguments as convincing? (Which is kind of a repetitive thing to say when you acknowledge they need new arguments).

            Oh, and you suggest that maybe libertarians are wrong and if so, they should change their minds. You say stuff like this a lot. You don’t ever point out that “libertarians” are wrong, you just like to scold people for not being sufficiently (as per your needs) sophisticated and thoughtful to consider they might be wrong. I notice you scold people about this a lot even though you never accuse them of actually being wrong. Seems like you just like scolding people in those cases.

            If I were to summarize your entire blog post into one sentence/idea, I’d go for something like this:

            “Libertarians focus on comparative advantage, which is not as convincing to non-libertarians, when they should focus more on incentives for resource allocation communicated through the price mechanism, when discussing inequality.”

          4. JCatalan

            I’d rephrase that last summary like this: “Libertarians should develop theories of income inequality to explain inequality not caused by comparative advantage.” It’s not that libertarians are wrong; it’s that they can’t explain as much as they think they can.

          5. valueprax

            Okay, and if we’re not talking about comparative advantage, then we’re talking about institutional factors (aka, initiation of force/violent intervention into the market place), are we not?

            Do you think libertarians don’t talk about this? Or is there something else you have in mind that you’re hoping people reading will guess at? Because I am stumped.

            And which “libertarians” are you speaking of here? People who got excited about Ron Paul and started a blog? Or people at ZeroHedge comments? Or people at Mises U? Published academics like Walter Block? Who?

          6. JCatalan

            Some libertarians talk about it, but most don’t and, in general, it’s not discussed enough when the subject of inequality comes up. I have in mind people who comment on this blog, and libertarian economists who comment on the issue of inequality (e.g. Don Boudreaux).

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