Capitalism and Inequality

Consider two hypothetical farming villages, each with ten households and ten parcels of land. In both villages, each household occupies a parcel at random.

In Luck Village, nine of the parcels yield at most a subsistence level of food, no matter how hard their owners work. The remaining parcel yields a vast abundance of food, also regardless of whether the household works hard or not.

In Effort Village, each parcel is identical. Moreover, the yield on each parcel depends on how hard the household works. Diligent households will have larger harvests than lazy households.

I think that nearly everyone would agree that if we lived in Luck Village, then it would be right for the rich household to share its bounty with everyone else. Even a Randian libertarian would admit that the rich household ought to share, although the libertarian might quibble over whether the rich household should be forced to share.

I think that nearly everyone would agree that if we lived in Effort Village, then sharing would be inappropriate and counterproductive. Even a radical egalitarian would admit that sharing would reduce the incentive of households to work by creating a “free-rider” problem. It is reasonable to predict that in Effort Village, sharing could make everyone worse off.

This thought-experiment about attitudes toward sharing is confirmed by survey data that evolutionary psychologist Leda Cosmides cited during a panel discussion at the Cato Institute in September of 2016.1 When people are asked their opinion about redistribution, their answer depends on whether the question is framed in a way that describes a situation closer to Luck Village or closer to Effort Village.

Unfortunately, capitalism’s defenders often take it as given that we live in Effort Village, and they treat capitalism’s opponents as if they do not understand the adverse consequences of sharing in Effort Village. By the same token, capitalism’s opponents often take it as given that we live in Luck Village, and they treat capitalism’s defenders as if they do not understand the fairness of sharing in Luck Village. We can think of these as the Uncharitable Arguments.

A more meaningful debate would focus on how phenomena that we observe can indicate how closely the real world resembles one village or the other. In the literature on capitalism and inequality, you can find people making points that speak to this issue, but the Uncharitable Arguments tend to dominate the discussion.

Winner and Losers

Both proponents and opponents of capitalism would agree that it is characterized by competition, resulting in winners and losers. I think they also would agree that the more winners there are relative to losers, the easier it is to defend capitalism.

For opponents of capitalism, invoking the phrase “the one percent” implies that there are relatively few winners and many losers. However, a proponent of capitalism is unlikely to find this persuasive. Is someone in the 98th percentile for income or wealth in the United States a loser? Surely not. In fact, proponents of capitalism will go on to argue that relative to the rest of the world, even people judged below the poverty line in the U.S. are winners rather than losers.

Proponents of capitalism are not willing to classify Joe as a winner or loser under capitalism by comparing his wealth to Fred’s. Instead, they would insist that we should classify Joe as a winner or loser under capitalism by comparing Joe’s well-being under capitalism to what it would be under socialism (or under a more generous welfare state). I think that this framing has to be accepted by opponents of capitalism in order for a meaningful debate to take place.

One of the more under-appreciated arguments in favor of capitalism is that future generations ought to be counted as winners. That is, regardless of the proportion of winners and losers from capitalism in America in say, 1800, economic growth since then has made winners out of modern Americans. The dynamics of capitalism are such that, looking forward a few generations, the proportion of winners from economic growth approaches 100 percent, and the proportion of losers approaches zero. That is, economic growth will make nearly everyone better off several generations from now compared to where they would be without any economic growth.

This same dynamism, however, produces what proponents of capitalism ought to concede are clear losers. People whose lives are adversely disrupted by innovation would be better off, at least in the short run, under a less dynamic system. The manufacturing worker displaced by globalization or technical innovation is a short-term loser.

Straight Shooters and Cheaters

Another perceptual difference between proponents and opponents of capitalism concerns the extent to which the winners in capitalist society are people who play the game honestly. Capitalism is more defensible if winners are predominantly straight shooters who play by the rules, rather than cheaters who exploit others through manipulation, subterfuge, monopoly power, etc. Proponents tend to point to examples of straight shooters, and opponents tend to point to examples of cheaters. If essentially every winner has achieved success by cheating, then there is a good case for taking away their winnings.

Proponents of capitalism emphasize that we should not conflate the inequality issue with the cheating issue. In their book Equal is Unfair, authors Don Watkins and Yaron Brook write,

We don’t admire innovative entrepreneurs because they create “good inequality” and we don’t despise frauds, thieves, and lobbyists because they create “bad inequality.” (Nor do we condemn a bum who robs a doctor because he creates “bad equality.”) What’s relevant is the nature of their actions—not whether the outcomes of those actions make people more or less equal.2

Proponents argue that we should punish cheating rather than punish winning. Of course, if you punish winning, you might indirectly punish some cheaters, but to proponents this seems like a very indirect and inefficient way of going about it.

Positional Goods Matter

A positional good is one in which what matters is your position relative to that of others. For example, the prize for winning The America’s Cup yacht race is a positional good. In such a race, there can only be one winner. This is in contrast with economic growth, which eventually makes winners of most of us.

Your place in the yacht race is determined by when you finish relative to other racers. With ordinary material goods, you care mostly about the absolute amount that you can enjoy, not with how your portion compares to that of someone else. With ordinary goods, it is possible for every one of us to raise our standard of living. With positional goods, if one person moves ahead, someone else necessarily falls back.

One argument against income and wealth inequality is that it allows the rich to dominate in the arena of positional goods. For example, I remember that in 1977 the America’s Cup race was won by Ted Turner, who was a television mogul. I find it plausible that in yacht racing, wealthier people are at an advantage.

The Wealth/Power Feedback Loop

Political power is a positional good that is especially worrisome. To the extent that rich people can use their wealth to gain political power at the expense of others, most people would agree that this is unfair. It is particularly troubling when we consider a feedback loop in which people’s wealth allows them to enhance their political power, which in turn allows them to enhance their wealth.

Opponents of capitalism want to fight the wealth/power feedback loop by limiting the capabilities of wealthy people. This means taxing the wealthy and using regulation to restrict their ability to deploy their wealth in the political process.

Proponents of capitalism want to fight the wealth/power feedback loop by limiting the capabilities of government. If government is less active, then it will not be tilting the playing field in favor of the wealthy, and the wealthy will have less incentive to try to influence government policy.

I would note that the wealth/power feedback loop does not necessarily go away under socialism. For example, in August of 2015, one report estimated the wealth of one of the daughters of Hugo Chavez, the former socialist leader of Venezuela, at more than $4 billion.3 Meanwhile, the rest of the country has become impoverished.

Improving Capitalism?

I believe that capitalist dynamism does produce losers in the short run. I believe that some winners are merely lucky. I believe that some winners acquired much of their wealth by cheating the system. I believe that wealth enables the rich to get more than their share of positional goods. And I believe that the wealth/power feedback loop is problematic.

I think that it is beyond debate that capitalism is imperfect. However, the more interesting question concerns how to try to improve it. There, a lot hinges on how one interprets the frequent failures of socialism as well as the failures of less-drastic forms of government intervention. To opponents of capitalism, these failures suggest a need to try harder to implement reform correctly. To proponents of capitalism, these failures suggest a need for reformers to back off. In that regard, I admit to being on the side of the proponents.