Wednesday, 26 February 2014

Acemoglu on inequality

From the Economist back in 2011 comes this comment by Daron Acemoglu about why inequality matters:
THERE are three main reasons why society may care about inequality. First, people's well-being may directly depend on inequality, for example, because they view a highly unequal society as unfair or because the utility loss due to low status of the have-nots may be greater than the utility gain due to the higher status of the haves. Second and more importantly, equality of opportunity may be harder to achieve in an unequal society. Many economists have, by and large rightly, focused more on poverty than inequality. Poverty not only causes low standards of living and poor health but damages both individuals and society by preventing those at the bottom from realising their potential, perhaps because they are unable to obtain a decent quality of education to prepare them for competition in the labour market. While poverty is clearly the more important factor in creating a non-level playing field, inequality may also be a nontrivial factor: those with greater wealth provide to their children resources and thus opportunities that the less wealthy cannot, and this may make it more difficult for society to achieve equality of opportunity.

Third and most importantly, inequality impacts politics. Economic power tends to beget political power even in democratic and pluralistic societies. In the United States, this tends to work through campaign contributions and access to politicians that wealth and money tend to buy. This political channel implies another, potentially more powerful and distortionary link between inequality and a non-level playing field. It may also create pathways from inequality to instability, because both the economic and political implications of inequality can create various backlashes.
The first argument may be true, but so could the opposite argument. And how could we ever measure people's utility anyway? The second argument is more about poverty than inequality per sec while the third is more a political argument than an economic one. You could imagine a state of the world where such an argument would hold but equally you could imagine ones in which it doesn't. A strong 'politics of envy' type effect could generate instability. But isn't instability more likely to be driven by poverty and people's react to that? Consider two economies, one where the four people in it have incomes of 1,1,1 and 1 and the other where incomes of these people are 100, 1000, 5000 and 7000. Further assume that incomes have been scaled so that 0 is the least acceptable level of income, say, for argument's sake that 0 means you are dead. Which of the two economies is more likely to be stable, the equal but poor one  or the wealthier but more unequal one?

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