Optimum Income Inequality

by Dave Schuler on March 5, 2014

There’s an interesting op-ed on inequality from Thomas Edsall in the New York Times today. In the op-ed Mr. Edsall takes note of the work of economist Richard Freeman suggesting that there is an optimum level of economic inequality from the standpoint of economic efficiency with inequality less than the optimum or greater than the optimum producing less economic growth than might otherwise be the case, creating a curve of outcomes reminiscent of the Laffer Curve. Here’s the part I think we should mull over:

Freeman argues that the costs of excessive inequality are high: “Inequality that results from monopoly power, rent-seeking or activities with negative externalities that enrich their owners while lowering societal income (think pollution or crime), adversely affect economic performance. High inequality reinforces corruption by allowing a few ‘crony capitalists’ to lobby politicians or regulators to protect their economic advantages. When national income goes mostly to those at the top, there is little left to motivate people lower down. The 2007 collapse of Wall Street and bailout of banks-too-big-to-fail showed that inequality in income and power can threaten economic stability and give the few a stranglehold on the economy.”

Let’s put that in terms of concrete actions and policies. Creating monopolies—like the cable companies, for example—produces less economic activity. Bailing out banks produces less economic activity. Bailing out automobile companies produces less economic activity. Innovations of the sort that the financial sector engaged in not all that long ago (“activities with negative externalities that enrich their owners, etc.”) produce less economic activity. Rent-seeking of the sort exemplified by the scandalous farm bill recently enacted into law by the Congress produces less economic activity. Giving your bundlers sweetheart loans for their ill-conceived sustainable energy projects reduces economic activity. Subsidizing the healthcare sector produces less economic activity.

Now, I can see how people (politicians, especially) feel the need to do all of those things anyway, for reasons other than economic efficiency. Fair enough. At some point don’t you either a) need to come up with a way to replace all that economic activity you’ve decided to sacrifice or b) just acknowledge that all of the jobs lost due to cronyism, rent-seeking, and so on just had to be sacrificed because you can’t make an omelet without breaking eggs?

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