The Ethical Economics
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ECONOMICS OF INEQUALITY

For most economists, mention of the term ethics applied to the economic system usually results in thoughts about income or wealth inequality.  This is partly due to a long-running literature, mostly in the mid-20th century, regarding the tradeoff between equity and efficiency.  The neoclassical economic system could be shown to deliver economic efficiency, but it could at the same time deliver a greatly unequal income distribution.  For example, an equilibrium in which 1% of the population receives 99% of the income, due to an unequal initial distribution of resources, can still be economically efficient after trade.   However, if there were a redistribution of resource endowments before competition and trade occurred, it would result in an outcome with a more equitable income distribution that would also be economically efficient.  Thus, one could argue that governments should adjust endowments, perhaps with taxes and subsidies, to generate a more favorable income distribution.  However, economists have mostly argued that the choice of an acceptable income distribution is a normative issue that lies outside the purview of the economics discipline.  In this way, the discipline has distanced itself from this particular ethical issue. 

This has perhaps been a wise approach since identifying the ideal distribution of income is surely a highly contestable normative issue unlikely to ever have a broadly accepted solution.   Poorer households would assuredly argue that redistributions from richer to poorer are warranted, whereas richer households may believe such redistributions are theft of their justly earned income.  Nevertheless, as pointed out by Piketty (2014) the evaluation of any income distribution by the population will depend on the way in which that distribution was achieved.  People may look more disparagingly upon inequality achieved via unequal initial distributions caused by, say, an accumulation of inherited wealth, as opposed to inequality achieved via a hyper-meritocratic system.  In the former case of inherited wealth, unequal outcomes arise more out of luck, whereas in the hyper-meritocratic system, unequal outcomes arise out of differences in natural abilities.  For the hyper-meritocratic argument to be valid though, the high incomes of corporate managers and CEOs in modern capitalist economies, for example, must arise because these individuals are extremely productive consistent with a perfectly competitive model.   If instead, their high incomes arise due to the presence of monopoly power, then the meritocratic argument breaks down.

In the end, the issue of income and wealth inequality is closely related to that of monopoly-power and competition.   Unequal income and wealth distributions result simultaneously from,

  1. The concentration of resource endowments in the hands of a small part of the population (i.e., inherited wealth and educational advantages),
  2. the advantages of monopoly power in certain industries, and
  3. from the distribution of natural talents (i.e., meritocracy).

 

Although the wealthy may prefer to believe that inequalities arise solely due to the natural distribution of talents, the unease about the extent of inequality in modern society has often occurred due to beliefs that inequalities arise largely because of the luck of inheritance or the exploitation of monopoly power.  In either of these cases, the acceptability of inequality is positively related to the extent to which the assumptions of the standard neoclassical model are fulfilled.  In a truly perfectly competitive economy with a reasonable initial distribution of resources (i.e., no monopoly in resource allocations), the inequality that arises is completely meritocratic.  In contrast, substantial monopoly power, either in resources or in production activities, would result in much greater inequality, than in perfect competition, and would contribute to growing concerns about the inequity of the income distribution.  

Steven Suranovic, December 1, 2019

Ethical Principles
Promoting Economic Efficiency

  • Three reasons for Inequality
    • Unequal distribution of productive resources
    • Monopoly Power in production
    • Natural distribution of talents
  • Inequality is not automatically economically inefficient
  • People have preferences over income distributions

 

Why?

  • Piketty (2014) points out that peoples' evaluation of society's income distribution depends on how it comes about
    • Unequal distributions based on inheritance are unpopular
    • Unequal distributions based on monopoly power also unpopular
    • Unequal distributions based on talent and effort differences are more tolerable

 

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When is Inequality Unfair? - Steven Suranovic, from on Vimeo.

 

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