Some of the best and brightest econbloggers are having a debate on whether there are negative externalities associated with wealth inequality, and whether these might merit government intervention to remedy. Unfortunately, the debate has gotten lost in a colorful, but unhelpful, discussion of "spite" (on the part of rich people) and "envy" (on the part of the poor). However entertaining this may be, it quite misses the point.

Very large wealth inequality has a huge, tangible negative externally in all existing political systems that has nothing to do with idiosyncratic emotional reactions. Wealth inequality leads to large, utility-destroying errors in public policy.

In the real world, under democratic capitalism, stalinist communism, feudal monarchies, you name it, there is a strong correlation between actual wealth and political power. (Under some systems this might be masked by differing institutions of wealth and property, but facts on the ground proved Comrade Stalin to have a nicer car than Comrade Sven.) Correlation is not causation: In some systems political power precedes wealth, and in others wealth brings with it the capacity to garner influence. Nevertheless, the relationship is strong, everywhere. The wealthy always have disproportionate political power.

Wealthy people — and I mean the best intentioned wealthy people, not the corrupt — make political decisions to improve the world as they see it. The greater the degree of wealth inequality, the greater the difference between the world those at the very top experience and the experience of the vast majority. This leads to errors in judgement, policy changes that improve the world the rich live in while harming the world that the not-so-rich inhabit, and very large utility losses when the not-so-rich are numerous. The best intentioned of the wealthy may try to mitigate this by reading, thinking about the less fortunate, etc. etc. But these exercises are a poor substitute for experiencing the world as most people experience it, and suffering the consequences of poor leadership directly. And power correlates with wealth much more than it correlates with diligence and skill in understanding the world beyond ones own experience.

Utility losses due to misguided generalizations of their own experience by the wealthy and powerful may be inevitable. But quantities matter. A society in which "the wealthy" represent a large fraction of the population who live not to differently from the less wealthy will make fewer and less costly errors than one in which a realtively small, very wealthy group lives very differently from the rest.

From the great spite and envy debate...

Steve Randy Waldman — Monday September 4, 2006 at 2:55pm [ 9 comments | 0 Trackbacks ] permalink