Is inequality good or bad?

Voltaire: “Equality is therefore both the most natural of things, as well as the most unreal.”
Photographed by Johan Fourie in the Pantheon, Paris (2013)

On 7 May South Africans will vote in the country’s fourth democratic elections, 20 years after the demise of apartheid. While there is little doubt about which party will win the elections, and who will be president, there is a general sense of frustration about the slow progress South Africa has made, especially in the last five years, to deliver on the promises of the post-apartheid government. Job creation will be, as always, central to most political parties election rhetoric: from the EFF (“creation of sustainable jobs“), the DA (“South Africans need REAL jobs“) and the ANC (as reflected in Zuma’s State of the Nation Address).

Yet job creation is the means to tackle a much deeper, more striking feature of the South African landscape: inequality. The pervasive difference in living standards that remain 20 years after the end of apartheid – between those living and working in cities and those in rural areas, between those with a good education and those without, and, unfortunately still, between black and white South Africans – is the conundrum that fixates much of our attention. And even though the EFF would want you to believe different, there are unfortunately no easy answers: a massive, state-led industrialisation programme, as history shows, exacerbates inequality, even though the faces of those in power may change. The ANC and DA, instead, propose to grow the economy piecemeal, by implementing market-oriented policies (with differences in emphasis), provide jobs (through the private and public sector), and raise all boats, so to speak. A less radical plan, but also a more proven one.

But regardless of which policies we implement, is it realistic to expect inequality to decline? Sure, some policies may reduce poverty, increase employment, but will it really reduce inequality? And, more fundamentally, should it?

A lengthy debate in the Daily Maverick recently centred around this question: Is inequality a bad thing? Johann Redelinghuys first argued that ‘inequality cannot be fixed’, so we shouldn’t even try to implement policies to attempt to do so. In response, Marelise van der Merwe argued that ‘inequality can and should be fixed’. It is fascinating to also read the comments section, although with the proviso that this is a biased sample of South African public (more educated, and more liberal). This debate mirrors a much broader literature in Economics, dating back at least to Adam Smith, who, many forget, was also critical of societal inequalities. (So, too, were other notable thinkers of the Enlightenment. See Voltaire’s quote above.) But with rising income inequalities globally over the last two decades, notably in China and the US, economists have had to think a lot more about this issue (see Branko Milanovic for more on this issue).

As a positive, inequality creates incentives to work hard. I remember reading a news article a few years ago about a new housing project in the North West province. The government had decided to build several dozen houses after protests by the inhabitants of a small town. One of the commentators on the news site wrote a remarkable story, which went something like this: I was born into a similar township as these individuals. When my friends stayed out late at night, my mother would force me to stay indoors, and study by candle light. I managed to do this for most of my high school career and, when I was the only one to get a C in matric, was fortunate to get a scholarship to go to varsity. It was hard. I failed one year, but finally succeeded with my engineering degree. I found a job, got married, bought my first house, which I’ll have to pay for the next 20 years. Now my friends in the township just got their houses for free. Is that fair?

As Redelinghuys notes, not all of us are born with equal ability, or skill, or determination. Some will rise faster than others, either because they work hard or because they are lucky. In a society where the incentives for self-advanced are removed – like communist societies – innovation, creativity, and entrepreneurship, the reason we’ve been able to improve living standards over the last 200 years, dies. If equality of outcome sounds like a great idea, travel to a former communist country that has remained closed to the market (like Cuba). It’s not a great place to live.

But – we are not born equal for other reasons too. Not only do we differ in ability, skill, and other human traits, we also differ because of historical reasons. Some of us happen to be born into a household where both parents have a university education. Others happen to be born into a household on communal land in the former homelands. Some of us happen to be born into a household with a single parent. Others happen to be born into a family with no income earners. Some of us are born more privileged.

These differences in our starting conditions expand over time. Wealthier parents can afford good nutrition, can send their kids to good schools, and even make sure that these schools are run well. They can provide the necessary health care, they can travel together, they can watch their weekend sport (and pay for sport tours, and equipment, and a school with good sport facilities). As these differences expand, so do our levels of income inequality, further deepening the divide. These high levels of inequality are bad, as Daron Acemoglu argues, for three reasons: 

First, people’s well-being [happiness] 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 … Third and most importantly, inequality impacts politics. Economic power tends to beget political power even in democratic and pluralistic societies.

Severe inequality of the kind we have in South Africa is bad because it removes peoples ability to compete fairly. Two Spanish economists expand on this in a new paper published in the Journal of Development Economics. Gustavo Marrero and Juan Rodriquez suggest that a country’s inequality can be divided into ‘inequality of opportunity (IO)’ and ‘inequality of effort (IE)’. These two types of inequality affect growth through opposite channels, so the relationship between income inequality and growth is positive or negative depending on which component is larger. They test this proposal using inequality-of-opportunity measures computed from a US database for 23 states of the U.S. in 1980 and 1990. As hypothesised, they find a negative relationship between inequality of opportunity and growth, and a positive relationship between inequality of returns to effort and growth.

In essence, Johann Redelinghuys believes that South Africa’s levels of severe inequality is the result of inequalities of effort: that poor people are poor because they are generally less hard-working and unambitious. In contrast, Marelise van der Merwe believes we are an unequal society mostly because the lottery of life predetermine one’s ability to rise to a high standard of living. As she notes anecdotally, “if you’re white and have money, you can be a drunk moron flunking on the bones of your ass for most of high school and as long as our marvellous education system pushes you through matric you can probably get into some kind of college and blubber your way into a job.”

Empirical evidence of our survey and census data suggests that Van der Merwe is much closer to the truth: with a few variables, including race, parental education and location, none of which any of us have control over, researchers are able to predict a person’s future income level fairly accurately. It’s not even only about race anymore: A black girl, born into a female-headed household in the rural Eastern Cape, will have a much lower income and living standard when she is 20 years old, than a black boy, born to parents with a university education in the suburbs of Johannesburg. Note that this statistical probability disregards that individual’s own effort, ability or determination to succeed. Inequalities of opportunity still trump inequalities of effort in South Africa, and by a long way.

The challenge is to design and implement policies that increase equalities of opportunity without decreasing inequalities of effort — policies that level the playing field without without changing the rules for some and not for others. Pure redistribution, of the sort the EFF propose, is unlikely to work. Here’s Larry Summers in the FT yesterday:

If income could be redistributed without damping economic growth, there would be a compelling case for reducing incomes at the top and transferring the proceeds to those in the middle and at the bottom. Unfortunately this is not the case. It is easy to think of policies that would have reduced the earning power of Bill Gates or Mark Zuckerberg by making it more difficult to start and profit from a business. But it is much harder to see how such policies would raise the incomes of the rest of the population. Such policies would surely hurt them as consumers by depriving them of the fruits of technological progress.

Summers proposes to redress inequality through market forces, notably the fiscal system:

It is ironic that those who profess the most enthusiasm for market forces are least enthusiastic about curbing tax benefits for the wealthy. Sooner or later inequality will have to be addressed. Much better that it be done by letting free markets operate and then working to improve the result. Policies that aim instead to thwart market forces rarely work, and usually fall victim to the law of unintended consequences.

To what extend the South African tax system can redress the inequalities of the past (without thwarting the incentive to work hard), is a tricky question. What is clear is that we need new ideas. Don’t expect any enlightened answers before May, though.