WhatsApp Underscores the Beauty of Income Inequality

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Thursday, news broke that an American had suddenly and dramatically joined the ranks of the superrich. Following the announcement Facebook was buying the company for $19 billion, WhatsApp's founders are poised for quite a windfall indeed. Cashing in on the innovation completes a food stamps to (potentially) Ferraris journey for one such founder-Jan Koum. Mr. Koum is now a living example that income inequality in America does in fact exist. But it isn't a sentence to permanent poverty. You see, income inequality is not inequality of opportunity; it's inequality of outcomes. Those outcomes, in a sufficiently capitalist economy, are the fruit of an individual's creativity and productivity-their innovation and action. (Innovaction!) There is no point to bemoaning the income gap if the American dream of improving your lot in life is intact. (Sometimes, a la Mr. Koum, dramatically so.)

Let's back up for a moment. For years, folks as disparate as millionaire and billionaire World Economic Forum attendees to Occupy Wall Street protestors have decried what they see as a growing concentration of wealth. They claim it's an economic risk; that America today is effectively an unsustainable Robin Hood tale in reverse. Politicians on the American left say government should intervene and do more to benefit "the middle class." On the right, politicians claim the growing gap is due to current Administration policies.

As evidence, most folks look to one of two factors: median income or the share of total national income earned by the top 1% of American earners. The latter is typically sourced to a study by Professors Thomas Piketty and Emmanuel Saez. However, that study has some asterisks worth noting. The figures most often cited are pretax and pre-benefit-that is to say, before the progressive income tax system we've had in place since 1913 and the varied entitlement plans this country has enacted in the intervening decades to address the very issue the paper raises. It also doesn't include only earned income-it counts capital gains on investments as "income," something the US tax code hasn't done in generations. Capital gains are wealth. They may be the result of high incomes. Or they might just be the product of successfully squirreling away cash and investing it wisely. Either way, a growing gap that includes capital gains is likely at least in part mathematics. Compound growth dictates that a household with little wealth would have to earn massive returns to outpace a household starting with far more wealth.

To "fix" the issue of capital gains inequality would require confiscating private property like stocks, bonds, real estate and more. This is a potential road to equality of outcome, but the outcome in the long run seems likely to look a lot like Berlin's Museum of Socialism, where you can see up close and personal East Germany's best-ever microchip that cost 100 times those made in the West at the time, was outdated at invention and never went into mass production.

Focusing on income inequality, whether you define equality by the point at which there are an equal number of earners above and below the midpoint or other means, is a red herring. If income mobility exists, then the people at different strata simply are not the same from one year to the next. Over time, some folks rise through the income/wealth ranks (e.g., Koum). Others fall, like Wesley Snipes or Lenny Dykstra (and soon, at his current trajectory, Justin Bieber). That mobility means there isn't truly a ceiling-Bill Gates' riches aren't preventing another American from becoming equally well-to-do. The amount of money in the country isn't finite, as it's all the product of economic growth. The global economy isn't a fixed pie where Gates' big slice means less is left over for the rest of us.

Ironically, as inequality talk ramps up, the argument's proponents seem to overlook a study by the same Emmanuel Saez along with Raj Chetty, Nathaniel Hendren, Patrick Kline and Nicholas Turner. The study, the Equality of Opportunity Project, found Americans' ability to graduate through various income strata hasn't much changed over time. The authors found that "the probability a child reaches the top fifth of the income distribution is 8.4% for children born in 1971, compared with 9.0% for those born in 1986." That's right-more people are reaching higher income strata. As the authors note, "the rungs of the income ladder have grown further apart (income inequality has increased) but children's chances of climbing from lower to higher rungs have not changed." (Emphasis mine.) Got that? Inequality has no bearing on folks' ability to improve their lot in life. Is it hard to advance? No doubt. But if it is no harder than it has ever been, how can one claim an income gap is an economic scourge of sorts?

In reality, it's the opposite. A separate study by the Brookings Institution found inequality is "sharply higher in economically vibrant cities" like San Francisco or New York, two areas with abundant high-paid jobs. The low end of the income gap scale is relatively fixed (you can't earn less than zero). But the top end is literally infinite. Inequality represents the abundance of opportunity in a given area, not a cap to it.

However, if it is truly equality of outcome you seek, then I assure you the ability for folks to climb those very same rungs will diminish. Not everyone is born with the vision and drive of Mr. Koum. Not everyone will take the risk and seize an opportunity to found a business. Not everyone is a great investor or saver. To equalize for this will basically require capping the opportunity of the very talented, the very motivated and the very risk takers our economy needs to remain innovative and competitive.


Todd Bliman writes about global financial markets and economics.  

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