Economic Inequality in NOT a Natural Phenomenon

By Akmal Zulkarnain

Ever since the full emergence of modern-capitalist society in the 1900s, inequality has been the subject of debate for many, including political philosophers, economists, social scientists, social activists, politicians, and policy makers alike. Though the term ‘inequality’ covers a plethora of different kinds and categories of inequality such as gender inequality, racial inequality, educational inequality, and the lot; one particular kind of it has been given a much higher attention vis-à-vis the others; economic inequality. In general, discourses in economic inequality is usually represented and defined by these two different proxies; ‘wealth inequality’ and ‘income inequality’, for these two variables – wealth and income – are the most readily measureable and observable. Wealth inequality can be defined as the unequal distribution of assets [both financial and physical] within a population, while income inequality is described as the extent to which income is distributed in an uneven manner among a population. To aid our reader throughout the discourses presented in this essay, our subject of inquiry would be limited by the boundaries set by these two definitions.

While most people perceive economic inequality as a social problem that needs rectification, quite a number of mainstream neo-classical economists, right-wing politicians and libertarian philosophers sought the opinion that economic inequality is natural, inherent within any typical society, and is an inevitable result of people having different productivities and merit. The phenomenon of perverse economic inequality that is experienced by almost every society in the world arises naturally out of a world where hardworking people get rewarded for their efforts, and others simply do not try had enough to obtain the same outcome.

Some of them, like the Austrian born Friedrich August Von Hayek even holds the opinion that inequality has a social function and is fundamental to a society’s progress. It is the freedom of a few capable of doing things that others do not, that prompted the society into advancements and progress. This view is later being translated into the modern-day ‘trickle-down theory’ in economics, where economic policies would always aim to favor the rich over everyone else, for it is assumed that the fortunes made by the rich through the benefits that they gained from tax cuts and lesser financial regulations would eventually ‘trickle-down’ to the benefit of each individuals belonging to different social economic strata in the population.

Eventually, all these would add up to the conclusion that economic inequality is not a social problem arising out of voluntary actions of any economic agents in particular, but rather a necessary feature of any human society and therefore is, inevitable. A question arises, are these claims valid? Are the populations of the 21st century modern day society doomed with the staggering effect of the ever increasing wealth and income disparity between the rich and the poor? Stiglitz, the recipient of the Nobel Memorial Prize in Economic Sciences in a report made for the Roosevelt Institute on ‘Rewriting the Rules of the American Economy’ argued that “Inequality is not inevitable: it is a choice we make with the rules we create to structure our economy. Over the last 35 years, America’s policy choices have been grounded in false assumptions, and the result is a weakened economy in which most Americans struggle to achieve or maintain a middle-class lifestyle while a small percentage enjoy an increasingly large share of the nation’s wealth.”

In general, it is firmly believed that stark economic inequality in a society has something to do with conscious actions of the policy makers, politicians, academicians and legislators. This phenomenon is not in any way ‘inevitable’, nor it is natural, but rather a product of unrestrained financialisation activities, biased government policies and flawed neoclassical theories.

Unrestrained Financialisation Activities and Unconstrained Growth of the Financial Sector

The cause of perverse economic inequality prevalent in our society can first be traced to the recent tendency of economic agents and individuals in the society to incorporate more and more profit-led motives into different areas of society, such as the households, industries and finance sector. It means to say that more financial activities such as giving out and taking up loans, investing in financial assets and instruments, innovations of new financial products and derivatives are penetrating the society at the level of households, corporations and financial institutions.

Households are lured to take on more household debts in order to finance their day-to-day needs and wants, such as to pay for their houses, education fees, or healthcare bills. Corporations are shifting their attention away from profit seeking through the means of commercial trading, towards seeking returns through financial trading. This process is being summarized into a generally accepted definition of ‘financialisation’ given by Gerald A. Eipstein as, “the increasing role of financial motives, financial actors and financial institutions in the operation of domestic and international economies”. What is so bad about ‘financialisation’ and the growing tendency of the society to be dependent upon it? And how would the ‘financialisation’ trend be linked with increasing income and wealth inequality in the society?

We may observe the linkage of ‘financialisation’ with rising inequality through four main routes; falling wages for labors in favor of profits for managers, investors and shareholders, greater inequality in pay between top earners and the rest, increasing concentration of wealth among a few people, and wealth generating property of wealth itself that has previously being concentrated among a few. With the growing trend of financialisation, the share of labor wages to total income measured by Gross Domestic Product (GDP) declines. On the other hand, the share of profit received by shareholders, private business owners, and financial investors increased substantially. It means to say that the vast majority of the population in the labor force is experiencing either a decline– or if they are lucky – an apparent stagnation in their wage rate, while the increase in pay for a few top bankers, financiers, and chief executive had been phenomenal.

In addition to that, the huge disparity in income received by ordinary labor and the top notch bankers and financier led to an even more hazardous problem; the concentration of wealth amongst a few in the society. The deregulation of financial sectors such as the removal of types, scale and restrictions on financial activities, shadow banking activity, as well as tax cuts for financial sectors speed up the rate of which wealth is being pooled into the hands of a few. Individuals and investors possessing capital would find it easier to undertake financial investments as a result of consistent deregulation of the financial sector by the authorities. This clearly favors the rich over those without capital, taking into account the fact that the poor are effectively barred from going into these high-return financial investments, unless they have huge amounts of capital to begin with.

To make the situation even worse, in a modern capitalistic society, wealth can generate even more wealth for the possessor. In a nutshell, this creates a vicious cycle where the financial sector creates a huge income disparity between the top 10% and the rest of the population, while the concentrated fortunes are being used to generate more wealth for those with them. As a result, wealth is siphoned from the poor to the rich involved in financial sectors, through interest payment made by the households that would eventually end up as profits for the investors and financiers.

The financial sector is deemed by some to be a very lucrative place to do investments. While it may be true for some that this particular sector would guarantee a handsome yield, it is often in the expense of others not directly involved with financial investments. The bloated financial system, fueled by the usage of fiat money is draining the wealth of the majority of the population while benefiting some. This inevitably will lead to the increasing wealth disparity observable in many capitalistic societies.

Biased Government Policies

As the biggest economic agent in most societies, the significance of the role played by the state has been recognized by many. If we take a venture into different economies around the globe, we would find that a significant portion of the perverse inequality happening in those societies can be attributed to biased government policies on behalf of the ruling state. As our subsequent discussions on the causes of inequality suggest, the phenomenon of stark economic inequality in our society is nothing natural, though to some extent it is recognized that in a society where people are being awarded according to their merit, a slight amount of inequality might prevail. Let us take a look into the phenomenon of inequality in the United States (U.S.) for a clearer perspective.

A report written by Stiglitz (2015) to the Roosevelt Institute suggests that while economic gains have asymmetrically pooled in the hands of the top 1% of the population, the income received by the others have stagnated (if not falling) in the past few decades. He goes on by explaining some of the causes to these startling trends to be the product of bad government policies in the 70s which were based on old and outdated models of economic development. For years, politicians, economists and policy makers are alluded with the conviction that there exists a definite trade-off between growth and equality. Which means to say that in order for a society to achieve substantial economic growth, we need to forsake the question of equality lest the aim of economic growth would be impeded.

What naturally followed from this conviction was political actions and laws that did not factor in the question of greater inequality in the decision making process. Policies are not directed to redistribute wealth to those at the bottom, but to pool more income for the top brasses in the economy – the one that (they believed) really moved the economy. The U.S. experienced a tax regime that raises insufficient revenues for the government (which can be explained by the consistent tax cuts for the rich) and focuses on short-term profiteering rather than long-term growth. The U.S. government has ever since created a ‘safety-net’ for ‘too-big-to-fail’ financial institutions, employed fiscal and monetary policy which were aimed to create more wealth instead of creating full employment (which would significantly reduce inequality), as well as dismantling workers’ unions and discarding transfer payments for labors that were supposed to create a support system for the households (Stiglitz, 2015, p.7).

It is therefore argued that the government policies do have some significant impacts upon the phenomena of inequality in our society, and we should not be led into believing that the government can (or should) do nothing to remedy it.

Flawed mainstream neoclassical economic theories dominating the academic world

One might wonder how the mainstream micro and macroeconomics theories are linked to the phenomenon of stark inequality in our society. It is thus believed that the mainstream neoclassical economic theories dominating the academic world has been contributing to this problem. The term ‘mainstream’ here is defined as ‘…that which is taught in the most prestigious colleges, gets published in the most prestigious journals, receive funds from the most important research foundations, and wins the most prestigious awards’. This sociological definition of mainstream economics is somewhat in particular referring to the neo-classical school of thought which is taught in almost every renowned high-level educational institutions throughout the world. For an average layman, the link between complex mathematical formula and complicated graphical analyses with real life phenomena of perverse inequality is somehow vague if not perceived to be non-existent. How can a 1000-page micro and macroeconomics textbook (which is highly unlikely to be read by the general public – unless you are a trained economist) be a dangerous threat to humanities, in its potential to produce one of the most loathsome problem in a society – inequality?

To begin with, most of the causes of economic inequality stated in our subsequent discussions have their roots in economic theories embedded in the textbooks. What makes the policy maker so sure that the ‘trickle-down theory of development’ would work, has its roots in the claims made by economists that surplus created by the rich would eventually ‘flow back’ to the betterment of the society (in the form of higher wages and compensation). What prompted bankers and financiers to demand deregulation of the financial sectors from the grasps of the government’s ombudsmen? The rooted faith that market economy enthusiasts have in the notion that free market is the best market form, and therefore should be left unregulated without ‘harmful’ interventions made by the state. All these economic ‘dogmas’ are in one way or another has their roots in the mainstream neoclassical economic theories.

In the past 20 years or so, many economists have come out with arguments and refutations against the neoclassical economics school. Among them is Professor Steve Keen, an Australian by birth and currently based in King’s College, London. He wrote a seminal work on this matter, entitled “Debunking Economics”, which as the name suggests, was written to overthrow the now dominating neoclassical school of thought. In it, Keen argued that the foundations of neoclassical economics is seriously flawed, in terms of the basic assumptions made by them, as well as the mathematical tools that they use to justify their models and conclusion. He claimed that these flaws are so apparent that even economists within the neoclassical school themselves admit them (but surprisingly, continued to show unshaken support for the school). They were educated into believing that the mathematical foundations of their theories are based upon sound mathematical reasoning (of which has repeatedly been refuted), and are not trained to appreciate the intellectual history of their own discipline.

Had they allocate some time to dig into the intellectual heritage left by the previous economists and intellectuals, they would find that their own convictions of their theories will crumble before their very eyes. The best example to illustrate this point is the model developed by Simon Kuznets – the American winner of the 1971 Nobel Memorial Prize in Economic Sciences – that served the purpose of explaining the trend of inequality prevailing in a developing economy. Kuznets formulated a theory where he proposed that “although inequality increases in the early stages of economic development, at some more advanced level, inequality begins decreasing”. This is represented graphically by an inverted U-shaped curve, and is accepted almost universally as the definite law of economic development, and was held on dearly by mainstream economists since then. What this theory suggests is that, we should adopt a rather passive attitude towards the problem of inequality, for eventually, as the economy advances, it would shift towards greater equality. Our attention should be on how to move the economy forward, not to the question of income and wealth disparity, as equality would be the ‘natural’ consequence of economic development.

Wisman pointed out that this notion of ‘progress over redistribution’ conveniently fit into the views of neo-liberal economists and free market enthusiasts favoring minimal government role.

Though in later years, Kuznets’ conjecture was proven to be empirically false (inequality worsened, even in highly advanced countries, such as the United States), a lot of mainstream economists still use his arguments to justify their reluctance on providing rectification measures for the problem. Interestingly, Kuznets himself admitted, from the very beginning when he formulated the Kuznets Curve that his ideas was characterized as “perhaps 5 percent empirical information and 95 percent speculation, some of it possibly tainted by wishful thinking”. This quote conveys the idea that Kuznets did realize the limitations of his theory, and even had the guts to explicitly mention it in his writing. He even made a very important remark (which is often brushed aside by mainstream economists) that in order for the study of inequality to be truly effective, inquiry into fields beyond pure theoretical economics (such as politics and sociology) is imperative, and called a shift from market economics to political and social economy.

The blame should not, in the end, rest upon the shoulders of Kuznets alone. It is the ignorance on behalf of the mainstream economists who took his ideas for granted, entirely dismissing his reminders of the limitations of the theory. What makes our future appears a little bit more gloomy is the fact that students of economics throughout the world is currently spending their time studying this school of thought, without being trained to be critical upon its propositions and assumptions. They, to use Keen words, are “educated into ignorance”.

Conclusion

As the preceding arguments suggest, it is firmly believed that economic inequality in our modern societies is not a natural phenomenon, far from being ‘inevitable’ or ‘necessary (as some economists and politicians would claim), but rather a product of bad government policies, false mainstream economic theories as well as unrestrained growth of the financial sector.

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