What's Wrong with Extreme Inequality?

by Michael Edesess, 6/3/14

It is common practice to use a single figure – gross domestic product (GDP) – as the definitive measure of progress. Relative standings of countries are assessed by comparing their GDP growth rates or their GDPs per capita. Times of crisis are compared to non-crisis periods by citing relative levels of global GDP growth. GDP per capita is routinely – and often unquestioningly – referred to as the “standard of living.”

But does it really measure progress or wellbeing? In a recent book, The Great Escape: Health, Wealth, and the Origins of Inequality, Princeton economist Angus Deaton measures wellbeing on a multidimensional scale. “The story of human wellbeing, of what makes life worth living,” writes Deaton, “is not well served by looking at only a part of what is important.”

In his book, Deaton turns a sharp focus on health, wealth and inequality in the distribution of those amenities. Some wealth inequality is inevitable and helps growth, he contends, but at extreme levels – which the U.S. may be approaching – it becomes counterproductive. He ends with an important chapter about international aid to less-developed countries, about which he has very strong opinions.

Wealth and satisfaction

Deaton also attempts to relate GDP to other measures of wellbeing, such as happiness. Different measures of “happiness,” however, produce markedly different results.

Deaton concentrates chiefly on a measure he calls “average life evaluation.” This measure results from a survey that is regularly administered in various countries by the Gallup Organization. In this survey, people are asked to “rate their lives by imagining a ‘ladder of life’ with 11 steps; the bottom step, 0, is ‘the worst possible life for you’ while 10 is ‘the best possible life for you.’”

Figure 1 below, from page 21 of Deaton’s book, shows each country’s average life evaluation – a number between 0 and 10 – plotted against national GDP per capita. The size of each circle is relative to the country’s population.

Figure 1: Life evaluation and GDP per capita on a log scale

Based on this graph, Deaton infers a rough correlation between a country’s GDP per capita and its average life evaluation. What is true of life evaluation, however, is not true when people are asked about happiness, worry, stress and anger. “Beyond a certain point (about $70,000 a year),” says Deaton, “additional money does nothing to improve happiness, even though those with more money report” higher life evaluations. Furthermore, “the national averages of worry, stress and anger are not at all related to national income.”

Perhaps “life evaluations” draw objective assessments from survey respondents, tending to reflect how they assume others would evaluate them. Thus, they are correlated with common objective measures of standard of living such as GDP. Reports of their levels of happiness, worry, stress and anger, on the other hand, are purely subjective.

Responses to questions about happiness can vary greatly across cultures. For example, Deaton, a Scotsman, notes that “in the United States, the pursuit of happiness is one of the unalienable rights enumerated in the Declaration of Independence, yet in the Calvinist Scottish village in which I grew up, such a pursuit would have been seen as indicating a serious weakness of character.” (Calvinism, with its dark view of human frailty and its doctrine of predestination presumably instills an austere and pessimistic ethic in the Scottish character.)

Health and wealth

The book is most enlightening in Deaton’s discussion of health. Health, as measured by longevity – that is, life expectancy at birth – is fairly well correlated with wealth across countries, with a few exceptions, as the figure below found on page 34 of Deaton’s book shows.

Figure 2: Life expectancy and GDP per capita in 2010 on a log scale

Longevity has generally increased in the last two and a half centuries as inflation-adjusted wealth has increased, though there are interesting aberrations and exceptions. For example, from 1550 to 1850, the general population of England enjoyed no secular increase in life expectancy, which lingered at around 40 years or a little below. For the first 200 of those 300 years, from 1550 to 1750, there was no increase in longevity among the aristocracy either whose life expectancies were the same as or even a little lower than the general populace. From 1750 to 1850, however, longevity for the aristocracy pulled strongly away from that of the general population, increasing to nearly 60 shortly after 1850.

The explanation for this is not certain, but Deaton suggests it was partly due to new Enlightenment attitudes, which made people more willing to defy accepted dogma and experiment with new techniques. Some of these were new medicines and treatments, which could be difficult and expensive to obtain and were therefore confined to the aristocracy.

More important than that, however, may have been an innovation called variolation, an earlier precursor of Edward Jenner’s development of inoculation in 1799. Deaton says:

Variolation was an ancient technique, practiced in China and India for more than a thousand years, and also long established in Africa. Material was extracted from the pustules of someone suffering from smallpox and scratched into the arm of the person to be protected; in the African and Asian versions, dried scabs were blown into the nose. The inoculee developed a mild case of smallpox but became immune thereafter; according to the History of Medicine Division of the U.S. National Institutes of Health, only 1–2 percent of those variolated died, compared with 30 percent of those exposed to smallpox itself.

After 1850, life expectancy began a steep and steady increase for the general population, doubling in England from 40 years to almost 80 in a century and a half. This occurred in two phases: first, the conquest of infectious diseases, and second, the prevention and treatment of chronic diseases.

Before the first phase, life expectancy was low, mainly because of the high percentage of deaths in early infancy. Around 20% of children died before their first birthday, according to Deaton, and even as late as 1910, 20% of girls died before their fifth birthday.

Most of the progress occurred in the first phase – life expectancy in England and Wales increased from 40 to about 70 between 1850 and 1950, primarily because of decreased child mortality. What accounts for this success? Says Deaton, “Decreased child mortality cannot have had much to do with medical treatments, such as new medicines or drugs such as antibiotics, sulfa drugs or streptomycin for tuberculosis, in part because most of the decrease in mortality took place long before such treatments were available, and in part because the introduction of the drugs did not result in any sharp changes in mortality from the diseases that they treat.”

Almost all of the increase was from improvements in public health and sanitation, motivated by the discovery of the germ theory of disease and the consequent realization that fecal contamination of drinking water was the primary cause of the spread of disease. To combat this cause, collective action was necessary to create public health and sanitation systems. Most of the improvement in life expectancy resulted from these public health improvements.

Of course, these improvements were completed only in richer countries. Many poorer countries still have very high levels of infant mortality and of infectious disease.

By 1950, infant mortality had been reduced to a small number in richer countries. Since infant mortality has a very high impact on life expectancy, only smaller increases could be made after that by extending the lives of the aged. The diseases that caused mortality were now not the infectious diseases that used to kill children such as influenza, tuberculosis and diarrhea, but chronic diseases that kill older people such as cardiovascular disease and cancer. In the second phase of increased life expectancy, these were tackled through a series of measures, including curtailing smoking and treating cardiovascular disease with antihypertensives, cheap diuretic pills that reduce high blood pressure.

Health, wealth and inequality

Much has been said about wealth inequality of late, especially since the release of the English version of Thomas Piketty’s book, Capital in the Twenty-First Century (which I reviewed in Advisor Perspectives). Piketty’s book tends to take it for granted that extreme wealth inequality is a bad thing, citing its evils: a plutocratic society owned by a few wealthy families on the one hand, and social upheaval in rebellion against that plutocracy on the other.

Deaton’s book does a better job than Piketty’s of explaining exactly what is wrong with extreme wealth inequality. Deaton’s argument is as follows: It is desirable for a nation to ensure equality of opportunity, though not necessarily equality of outcomes. However, extreme inequalities of outcomes – extremes of wealth – can undermine equality of opportunity. Those who are successful have every incentive to pull up the ladders of opportunity behind them to ensure that others will not follow. “The newly rich,” says Deaton, “may use their wealth to influence politicians to restrict public education or health care that they themselves do not need.” If the newly rich are extremely successful, their wealth can be lavishly applied to both public information (and misinformation) dissemination and private lobbying of politicians and bureaucrats in an effort to limit others’ opportunities and to enrich themselves further.

Deaton cites evidence that political lobbying has played a key role in the increase in top incomes: “Changes in what might appear to be arcane or obscure rules on how markets operate, on what firms can and cannot do or on accounting rules can mean immense sums to particular interests. … Rules are set not in the public interest but in the interest of the rich, who use those rules to become yet richer and more influential.” And the costs to the wealthy, he claims, of political lobbying and campaigning are extremely low. “Even the costs of recent presidential elections are dwarfed, for example, by the annual advertising budgets of car manufacturers,” Deaton writes. “Political favors come amazingly cheaply relative to the potential benefits.”

All of this threatens democracy itself, according to Deaton: “The political equality that is required by democracy is always under threat from economic inequality, and the more extreme the economic inequality, the greater the threat to democracy.”

It is very difficult, I believe, to contradict Deaton. The counterarguments usually mustered to arguments like his are in fact arguments that at least some inequality is necessary in a free society. That proposition is virtually counterargument-proof. The same arguments, however, cannot be used to claim that extreme inequality is a good thing.

Inequalities of health and wealth across nations

In his final chapter, Deaton launches a devastating blast against international aid programs intended to lift people in less-developed countries out of poverty. These programs, Deaton claims, prop up bad governments and make donors feel good but do less than nothing for the poor of those countries. The funds donated, he points out, are fungible – so when they go to governments, or even to non-government organizations, there’s no way to guarantee that funds intended for clinics or food relief do not wind up being redirected, for example, to weaponry. Deaton says there have been cases where donor funds have ended up supporting murderous militias.

The autocratic governments of the poorest countries have incentives to keep their countries poor, so as to keep the donations – which are generally directed through the countries’ governments – coming. Deaton recounts one of the worst cases, in which “government officials in Sierra Leone held a party to celebrate the fact that UNDP [United Nations Development Program] had, once again, classed their country as the worst in the world and thus guaranteed another year’s worth of aid.”

Deaton gets into specifics about what kinds of programs are good for developing countries and which are not. In the area of healthcare, many of these countries have high infant-mortality rates similar to those of the rich world before the germ theory revolution led to public sanitation and the near-eradication of infectious disease.

Nevertheless, aid assistance for health care clinics and public-health programs does not always work. It is subject to the same fungibility issues and can rob local government-sponsored health-care systems of their limited supply of productive workers who may find amenities or compensation more attractive at the aid-sponsored facilities, thus undermining any existing nascent local government effort.

Deaton says that the few things that can work include vertical health programs, run by an agency such as UNICEF as well as some private philanthropies like the Bill & Melinda Gates Foundation. These are single-disease programs to “helicopter in” a specific targeted solution for a specific disease – for example, vaccination programs for polio or mosquito control for malaria.

Adam Smith and the vanity of the rich

As Deaton reminds his readers, Adam Smith was not only interested in the utility of capitalism but its moral aspects as well:

Smith was skeptical about the personal benefits of wealth. Indeed, in his Theory of Moral Sentiments, Smith described the idea that wealth would make us happy as a deception, albeit a useful one “which rouses and keeps in perpetual motion the industry of mankind.” He was also skeptical about the extent of inequality, arguing that the rich, by employing others “in the gratification of their own vain and insatiable demands,” brought about an approximately equal distribution of the “necessaries of life.”

This may be true, and it offers an argument why inequality is not a bad thing. As I have previously written, none other than liberal economist Paul Krugman has offered the very same opinion as Smith (whether knowingly or not), in debating a point of inequality with his economist compatriot Joseph Stiglitz:

So am I saying that you can have full employment based on purchases of yachts, luxury cars and the services of personal trainers and celebrity chefs? Well, yes. You don’t have to like it, but economics is not a morality play, and I’ve yet to see a macroeconomic argument about why it isn’t possible.

Yes, inequality can be both an effect and a cause of increased wealth for all. But when the fruits of inequality at the top are used to subvert the democratic system, it is quite possible that – as both Deaton and Piketty would agree – everyone’s freedom, and even their wealth, are at risk.

Michael Edesess, a mathematician and economist, is a visiting fellow with the Centre for Systems Informatics Engineering at City University of Hong Kong, a partner and chief investment officer of Denver-based Fair Advisors and a research associate at EDHEC-Risk Institute. In 2007, he authored a book about the investment services industry titled The Big Investment Lie, published by Berrett-Koehler. His new book, The Three Simple Rules of Investing, co-authored with Kwok L. Tsui, Carol Fabbri and George Peacock, will be published by Berrett-Koehler in spring 2014.