Inequality doesn’t matter. Or, rather, it shouldn’t matter to policymakers if they are interested in fighting poverty and improving people’s living standards. A new paper by the Legatum Institute’s Dalibor Rohac published by the ASI this week, Does Inequality Matter? (PDF), exposes the fallacies behind the contemporary focus on income inequality and argues that it is a fundamentally flawed measure in policymaking.
Equality measures tell us nothing about how well-off people are, and rising living standards across the board are often accompanied by increases in inequality. If the poor get richer, and the rich get richer even faster, inequality rises but everybody is better off. Is this really a scenario that we want policymakers to try to avoid? Few poor people care whether the rich in their society drive BMWs or Rolls Royces – what they care about is the opportunities and living standards for them and their children. As the paper shows, government policies that try to "narrow the gap" between rich and poor, rather than raise the bottom up as fast as possible, are facile and misguided.
The inequality measure is flawed for another reason as well: its focus on nation-states as single units. The Gini coefficient – the standard measure of income inequality – only compares income levels within individual nation-states. Is this a useful measure, when people are more mobile than ever? Perhaps not. Rohac uses the example of a middle-income worker moving from Guatemala to the United States. This person, who was earning an above-average wage in Guatemala, now earns a below-average wage in the United States that is nevertheless significantly larger than his Guatemalan wage. She is better off by any absolute measure – and perhaps has some extra money to send home – but inequality in both countries increases. It’s hard to judge exactly how much of an impact this has on inequality measures, but it should underline the conceptual difficulties involved.
Rohac also deals with the arguments made in The Spirit Level, which argues that happiness is significantly influenced by income inequality, and the argument made by Joseph Stiglitz that the financial crisis was caused by inequality. At a time when development aid and domestic poverty are at the top of the agenda, the paper is a valuable and thought-provoking addition to the debate.