Worry Over the Wealth Gap Is Wasted

"This is how wealth is produced in society: countless individuals seek to meet their own needs by meeting the needs of others." - Steve Forbes and Elizabeth Ames, How Capitalism Will Save Us, p. 12.

Writing last August in the New York Times, David Leonhardt and Geraldine Fabrikant observed that "The rich have been getting richer for so long that the trend has come to seem almost permanent." The Financial Times' Chrystia Freeland confirms the musings of Leonhardt and Fabrikant with statistics showing that in the United States, the top 1 percent of earners presently capture 24 percent of income, whereas the bottom 50 percent account for just 13 percent.

Freeland feels that this "increase in income inequality is a troubling conundrum," and she's joined in her concern by software entrepreneur Jim Manzi who recently wrote that "if we let inequality and its underlying causes grow unchecked, we will hollow out the middle class - threatening social cohesion and eventually surrendering our international position."

Both Freeland and Manzi seem to embrace the notion that our society's greater good and future wealth-creating capacity is a function of social cohesion. They conclude that we must moderate the wealth gap in order to make continued wealth creation a reality.

The problem with this thinking is that wealth in a largely free society is rarely achieved by force.  Instead, wealth creation drives creativity and is almost invariably shared with those not wealthy. In any case, short of reducing the broad standard of living in the U.S., there's nothing we can realistically do about it. In that sense, a wise response is to embrace differences in achievement and reduce the government's role in the economy to making everyone equal before the law.

There's not enough wealth to bridge the gap. Ludwig von Mises long ago observed that "at no time has there ever been a people which has raised itself without private property above a condition of the most oppressive penury and savagery scarcely distinguishable from animal existence." Assuming a desire to moderate inequality in private property or wealth ownership, is there anything policymakers can or should do?

Logic tells us no, and the reason concerns the almost tautological reality that wealth is scarce: there are very few wealthy people in the U.S. relative to large numbers that would be considered "middle class" or "poor." So even if we pursued some form of wealth redistribution to reduce financial stratification on the way to social cohesion, there's quite simply not enough wealth in ours or any society to achieve what is a utopian goal.

If attempted anyway, the logical means would be to impose draconian rates of taxation on the highest earners among us. On its face we can see how this wouldn't work. First, as President Calvin Coolidge once noted, "There is no escaping the fact that when the taxation of large incomes is excessive, they tend to disappear." Assuming nosebleed rates of taxation, it's a fair bet that the achievement-oriented in our midst would go to great pains to hide their income from the tax man.

Second, to a high degree the driver of economic effort is the desire among industrious individuals to reap the benefits of their work effort. If taxation reduces the gain captured by the next dollar earned, the incentive among individuals to pursue the kind of work that produces large amounts of wealth is attenuated. In short, the wealth available to be redistributed exists thanks to a tax code that allows individuals to keep the bulk of what they earn.

Third, as von Mises so eloquently noted, private property itself is what distinguishes evolved societies from those that are savage. If social cohesion is a societal good as some say, the most unlikely way to achieve same would be to socialize private gains.

How is great wealth created? In considering how wealth is created, it should be said that the economic interest or greed of the entrepreneur must logically coincide with the needs of the consumer. Rarely, in a free society underpinned by the rule of law, is great wealth achieved at gunpoint.

From the mass-marketing of Ford automobiles in the early part of the 20th century, to Microsoft software in the '80s, and Dell computers in the '90s, entrepreneurs Henry Ford, Bill Gates and Michael Dell all became immensely wealthy producing for a large market of consumers that extended well beyond what some economists would deem the "rich."

It's fair to argue that the larger the profit, the larger the unmet need which has been met. Societal critics like Freeland and Manzi are eager to decry big gaps in wealth, but one way to calm their nerves would be to consider how Amazon's Jeff Bezos, FedEx's Fred Smith and Facebook's Mark Zuckerberg (to name but three) attained their wealth positions. They'll find that such financial success was a function of pleasing consumers at all levels of income.

Critics often point to the wealth concentration on Wall Street, arguing that nothing is produced there, and that the practitioners of finance allegedly offer no "social utility." But this too is a thoughtless and blind protest. The symbol that is Wall Street offers enormous social utility by starving incompetent managers of the capital they are apt to waste, while providing funds to the managers who deploy capital wisely. This is Wall Street's economic function.

Indeed, Amazon, FedEx and Dell were all able to grow on the way to fulfilling customer needs thanks to finance of Wall Street origin. As for the financiers who grew rich amid the financial crisis of 2008 through short sale bets placed on mortgage securities, they too helped society to mitigate the ensuing collapse through their efforts to unmask and cleanse the economy of non-economic investment.

Today's luxuries are tomorrow's necessities. In his 2007 book, A Farewell to Alms, UC Davis economics professor Gregory Clark made the essential point that the lifestyles of today's rich predict "powerfully how we will all eventually live if economic growth continues." That is, today's unattainable luxuries are tomorrow's easily accessible necessities.

Examples abound. In the 1987 film Wall Street, many moviegoers no doubt looked to the screen in awe when the movie's main character, Gordon Gekko, talked from an enormous mobile phone from the beach. This once unattainable luxury is now commonplace around the world, and prices of this former bauble of the rich continue to fall in concert with the size of the phones.

Just the same, today's most prosaically inexpensive computer on offer from Dell provides exponentially more gadgetry, memory and speed than the most expensive computers for sale in the '90s. Considering automobiles, the most basic on sale today increasingly include CD players, GPS systems and braking systems that were all but unheard of in top-of-the-line luxury models of the '80s and '90s.

In this sense, the luxuries of the rich incentivize the wealth driven entrepreneur to create for the mass market what was once only available to the super-rich. At present, private jets are mostly the property of the very wealthy, but there are doubtless entrepreneurs working feverishly to make them commonplace.

Consider the recent health care legislation meant to "bend the cost curve downward." The thinking underpinning this argument gets economic realities exactly backward. As with the increasing availability of what were once luxury items, the goal with health care should be to allow doctors to charge nosebleed prices for innovative new cures purchased by the rich so that young doctors on the way up have practices that can make a profit from catering to the non-rich.

Von Mises found that the notion of "luxury" is historical in nature, and history has proven the prescience of his words. What passes first as ostentation (such as a brick-size mobile phone) eventually becomes so prevalent among the non-rich that it is taken for granted.

Government measures that tax the attainments of the rich tend to block entrepreneurs from creating for the mass market the luxury items that initially fulfill the needs of only a few. Better it is to embrace "conspicuous consumption" with an eye towards the eventual democratization of that same consumption.

Without capital, there are no entrepreneurs. If it's tautological that wealth is scarce, a similar tautology must be that free capital is scarce too. By virtue of being wealthy, the rich almost by definition have capital to spare. This is an essential point with regard to the wealth gap. To escape the tax man the rich can hide their savings under the proverbial mattress. Alternatively they can invest them in banks, put them to work in the stock market or place them with venture capitalists.

Even if the savings are consumed, entrepreneurs are stimulated to produce high-end consumption goods that they can make available to everyone on the way to financial success. The buying habits of the rich signal to those in a free society what they'll eventually get to enjoy.

Of course entrepreneurs can only innovate if there is capital available for them to pursue their ideas with. So if the goal of politicians is to expropriate and redistribute wealth, it must then be said that the result will be to starve the very entrepreneurs who work to improve the lives of the non-rich through invention.

Since governments lack any resources other than those taxed or borrowed from the private sector, politicians who seek to eradicate societal unease through redistribution must as a rule be reducing the amount of private capital necessary to fund entrepreneurial advances, and thereby wage growth. To reduce the wealth gap governments must compromise the ability of the non-rich to improve their status.

Wealth gaps drive creativity. In his 1983 book, History - The Human Gamble, economist Reuven Brenner made plain that "it is the perception of inequality that induces people to take risks." The more we envy the success of others, the more likely we are to gamble on the next big idea.

So while establishment thinkers may buy into the notion that equality is an overriding social good, the resulting policies get in the way of economic growth and wealth creation. It's the existence of inequality that gets the innovators among us thinking about creative ways to reduce the gap of wealth that already exists. If a great deal of inequality didn't exist, it would have to be invented as a way of concentrating the minds of budding entrepreneurs.

Some might argue that extreme differences in income inequality are unacceptable, but Brenner has found that even this is not true. As he put it, "the lower one falls in the wealth distribution, the greater will be one's incentive to gamble."

In this very real sense we can perhaps see why Michael Bloomberg, let go from Salomon Brothers, gambled on the eponymous Bloomberg terminals which dot Wall Street trading floors on the way to billions. In a smaller way, one need only visit any restaurant in Beverly Hills to witness waiters and waitresses putting in long hours at night in order to free up time during the day for film and television auditions. It is the craving for things we don't have that makes us gamble on entrepreneurial concepts and professions which might enrich us.

Conclusion. One of the oldest economic concepts concerns trade-offs. For every economic good that is created, there must be an unfortunate, or negative accompaniment.

Perhaps the trade-off that comes with prosperity is that certain individuals see great wealth but are blind to the problems solved on the way to creating it. Wealth at the far end of the income curve has in a sense distracted us from realizing how much better we live thanks to wealth creation, and how much better off we are in relative terms owing to individuals pursuing innovative ideas.

Ultimately we should embrace the wealth gap. Wealth inequality itself will foster increased access to former luxuries, greater opportunities to innovate thanks to free capital, and enhanced creativity.