Capable men have unique personalities and come from a wide array of backgrounds and experiences, but there are some characteristics that we all share. One of those shared traits is the capacity for independent thought. Capable men have purposefully reasoned beliefs that have been thoughtfully formed from knowledge and experience, not simply inherited second-hand from others. This leads us to often be contrarian in our thoughts and actions; however, this contrarianism is not simply being stubborn for the sake of going against the tide, but rather we think and behave counter to the masses because we have learned that following the herd is usually a recipe for disaster. Sheep find comfort in the herd right up until the day they march single-file into the slaughterhouse. But we aren’t sheep; consequently, we have developed the habit of analyzing and thinking through our opinions without much consideration for popular opinion. This doesn’t mean our opinions are always right, but they are always our own. This also leads us to be a little slower in our reactions to certain trending buzzwords that are designed to spook the herd and direct them down a certain path of thought. One of these buzzwords currently in circulation is “income inequality”. The mere mention of this term is intended to set off alarm bells in the mind of the listener that ring “unfair! unfair! unfair!”. Pundits in financial and political media (not to mention social media commentators) use this term to highlight the “unfairness” of society, lamenting the fact that CEOs make [fill in a popular number] times the income of lower-level workers. The mantra then gets repeated, “the rich get richer while the poor get poorer”. But what does income inequality mean, and is it really a bad thing? Fortunately, we are not at the mercy of punditry or popular opinion; so let’s think through this problem and form our opinion.
What Is Income Inequality?
Like most alarmist buzzwords, the definition is usually vague and usage broad; so we need to define the scope of the term in order to analyze it. When the term “income inequality” is used the idea being conveyed is “there are people are have a massive amount of wealth compared to others”. Now, we know that “wealth” (net worth) is not the same thing as “income” but the average person thinks in terms of their paycheck rather than their net worth which is why the pundits use that term. .The intended implication is that, “there are people out there making millions while you slave away for your paltry salary”. In actuality, real salary income of CEOs of publicly traded companies is quite low relative to compensation via performance-based bonuses and stock options. Also, there are individuals with higher than average income that have very low net worth in terms of capital and assets; so annual income is not a very good indicator of the ratio of wealth between two individuals or groups, but facts aren’t usually too important when trying to agitate sheep.
So how do we frame this issue? For our purposes, we actually need to look at both income (capital inflow) and total net worth (accumulated capital) because both metrics have an impact on distribution of wealth. We will view the term “income inequality” as the gap in both income and net worth (separately) between in individuals in the top 1 percentile versus the bottom 1 percentile.
Where Does Income Inequality Come From?
Does Santa Claus fly around the globe once a year, dropping assets down random chimneys, and some lucky individuals receive millions while the unlucky ones receive only hundreds? In our universe, that is not the origin of income; so, if it isn’t from Jolly Saint Nick, from whence does income originate? Income is simply a function of production. Either you must produce something the market values highly or you must produce a vast amount of something the market values lightly. An example of high value production would be Rolex watches. Rolexes are valued highly by the market, e.g. there are many people willing to pay a high premium in exchange for one of these watches, which means Rolex can command a high profit margin and high net income as a firm. Inside the firm, the watchmakers at Rolex command a high income because there are few expert craftsmen in the world that can produce these watches. However, the janitors that clean Rolex’s offices do not receive the same level of income as the watchmakers because there is a large quantity people who have the skill to clean offices versus a small quantity of people who have the skill to construct watches and the high market value of the end product ensures higher income to those workers that provide high value to the process of production, i.e. the watchmakers. Both the watchmakers and the janitors are involved in the production of watches, but the value they contribute to the final product is not the same and accounts for the difference in their income. However, this does not mean that janitors cannot earn high income. In fact, a janitor may earn more income than a watchmaker. Consider a hard-working janitor that takes extra jobs on weekends and suddenly finds himself with ten offices as weekend customers. The workload is too much for one person; so, he begins hiring others to join the firm. As time goes on, through marketing and accrued reputation, he ends up leaving his “full-time” job to service the 40 offices that are now on contract with his firm. From there, he continues to expand outside his locality and grows to service hundreds of offices with a large employee base. This simple janitor could easily be earning higher income than watchmakers, doctors, or lawyers which is our second example: producing a large amount of something the market values lightly. While it is true that janitorial services per unit carry less market value than watchmaking, if you can produce those services on a large scale, it is still possible to generate high income.
It should be clear from these examples that income is a direct function of productivity and market value of that productive output. So, the question then becomes: why should we expect incomes to be equal when it is obvious that different people produce different values of output?
I shouldn’t have to point this out, but human beings are unique individuals with different sets of knowledge, talents, opportunities, and choices. Why should we expect highly incongruent people to have similar incomes? There is a high degree of income inequality between me and LeBron James. Is this unfair? Of course not, this inequality reflects his ability to add value to millions of people’s lives by his performance on the court and add value to large brands via sponsorships. LeBron produces more value for the market than I do and that is reflected in our income differential.
People are not Stuck in their Income Tier
Those who lament income inequality seem to view “the rich” and “the poor” as static classes of people, assigned at birth with no possibility of mobility between those classifications. However, markets are highly dynamic and individuals who are poor today, through an increase in productivity and capital accumulation can migrate upward to become one of “the rich”. Conversely, a rich individual can fall from their perch into poverty (as the CEO of FTX recently discovered). There simply isn’t a large, fixed gulf between the rich and poor that cannot be crossed. There is a constant flow of capital throughout a very dynamic, global marketplace, and those are poor today find ways to produce and invest their way upward while those who are rich can slide down the wealth ladder resulting from malinvestment and bad decisions.
Do the Rich Really Get Richer and the Poor Get Poorer?
Now, we will shift our focus from the subject of income to the subject of net worth. Although the average person equates high income with wealth, the term “rich” actually refers to an accumulation of valuable assets not simply one’s annual flow of income. From this perspective, it is clear that the “rich” are those with investable capital to take risks, start businesses, invest in public markets, build buildings, etc. Those who put forth the capital and assume risk obviously should and will be rewarded by the market if their investments are smart. This creates a capital accumulation effect concentrated around those who already have a high degree of wealth. But this capital accumulation comes from providing the market with goods and services that it values which means the entire market benefits, not just “the rich”. Think of how many “poor” people have benefited from Amazon, as workers, delivery drivers, and even sellers on the Amazon platform. Yes, Jeff Bezos got rich in the process, but isn’t the whole of society much better off from the value created by Amazon? The wealth that Amazon generates flows out to millions of people in a complex marketplace and industries in its orbit. What if Amazon didn’t exist? There would be less income inequality between Bezos and his peers, but would the world be better off? I think not.
So are the poor really getting poorer? Actually, they are getting poorer but not because the rich are getting richer. They are getting poorer from high levels of consumer debt, inflation, taxation, and generally being stuck on a hamster wheel of trading time for money and not being able to accumulate real capital. But again, this state is not induced by the rich, because the rich can only accumulate wealth by producing value for the masses.
Income has Nothing to Do with Value as a Human Being
Income inequality zealots can’t seem to separate the value of an individual’s economic output from their value as a human being which are wildly different things. In their perception, it is a terribly sad state that some people have substantially more than others. They feel that it is unfair that “good” people who struggle financially while others live a life of (assumed) ease. While these arguments may pull on the heartstrings, they have no basis in reality. My mother is undoubtedly a better person than I am, but she has never been rich. One contributing factor to that is the fact that she chose to focus much of her energy on raising me and my sister as a single mother. On the other hand, if a lab researcher who moonlights as a serial killer on weekends develops a cure for cancer the market would reward him with a very high income. His murderous tendencies would be irrelevant to the market because the market only evaluates productive output, not the producer’s quality of character. The rich and poor are not inherently better or worse human beings solely because of their income level. Poverty comes from low value productivity. There may be many reasons for low productivity, but it isn’t “unfair”, it simply the nature of reality.
How Much Should We Worry about Income Inequality?
Not Much. Income is directly correlated to the market value of an individual’s productive output. Those who provide higher value to the market receive a higher income in return. Human beings are unique and differ widely in knowledge, talent, location, work ethic, goals, and motivation. All these factors (and many more) impact the productivity level of individuals, leading to wide disparity of income levels. As long as human beings are different, there will always be differences income inequality, and It is not a problem to be solved; it is simply a reflection of the underlying productivity of unique humans participating in the market. Individuals’ productivity can change over the course of their life, leading them to move up or down the income scale. There are always fewer high output producers than average and low producers which can create the illusion of a concentration of wealth within the high-productivity segment; however the value these highly productive people generate for the market benefits the entire society across all income levels more than the income these individual receive back from the market. Of course, there are people who are luckier than others, have more access to opportunity than others, more natural talent than others, which makes it easier for them to accumulate wealth, but there is no law, policy, or system that can eliminate these imbalances. Welcome to earth. It ain’t utopia.
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