Income Gap Nonsense

South Africa desperately needs a much bigger income gap.

That’s right. The income gap is growing far too slowly, and recent articles and comments lamenting the “growing” or “excessive” income gap are all nonsense.

The absurdity of wanting a smaller income gap is not about racial or social justice, or inequality and the legacy of apartheid. It is much simpler than that. It is an obvious fact of elementary arithmetic. Anyone who thinks about it rationally for a few seconds realises that the income gap can be reduced only if things are made worse for intended beneficiaries.

And, no, being for a bigger income gap does not make one reactionary or conservative, or a protagonist of efficiency-promoting competition. Even socialism, fascism or communism can benefit the poor significantly only if the income gap increases.

“The poor are getting richer, but the income gap is growing” anguished a recent newspaper article. This was reminiscent of a BBC World programme aired on April 4 2006 which claimed that one of China’s biggest problems is that its high rate of economic growth was causing the income gap to increase. The absurdity of this concern is that whenever there is increased prosperity, even when the poor get richer much faster than the rich, the gap grows.

Although it is hypothetically possible for the poor to get richer whilst the gap declines, it is so improbable as to be an absurd policy objective. Policymakers often fall for the income gap fallacy and adopt counter-productive ‘income redistribution’ policies in good faith. But simple arithmetic explains why poor people usually benefit more from growth than redistribution.

Poor people in rich countries are much better off in absolute terms than their counterparts in poor countries – and they know it. This is why the poor migrate lawfully or unlawfully usually from countries where governments redistribute more to rich countries with fewer hand-outs, especially for immigrants. “Income distribution” in poor and rich countries is similar. Typically, the richest five percent have one hundredfold what the poor have; if rich countries are ten times wealthier than poor countries, the poorest people in rich countries tend to be ten times richer than poor people in poor countries. If the poorest 20% in rich countries such as the USA were a separate country, they would be one of the world’s wealthiest countries. In other words, poor people in rich countries are poor only by comparison with the world’s richest elites.

Confused critics of economic growth anguish needlessly about the fact that the white-black income gap grew during the USA’s prolonged high growth period (Reagan through Clinton). The growing gap was presumed to mean that the rich were getting richer and the poor were getting poorer, whereas the poor were getting richer faster.

Income Gap Sense
The reason why concern about the income gap is misleading is clear from very simple arithmetic. If rich person A has an income of R100,000 and poor person B has R1,000 (a typical rich-poor ratio) the gap is R99,000. The gap will be about R10,000 bigger (R99,000 to R108,900) if they both get 10% richer (R110,000 and R1,100 respectively).

If A has 10% more whilst B gets a stupendous 100% increase, B is overjoyed … until some do-gooder points out that the ‘gap’ grew by R9,000.

By how much will B’s income have to grow merely to maintain the initial R99,000 gap? As this table shows, an impossible 1,000%.

Person	Income	Growth	Result	Gap
Rich	R100,000	+ 10%	= R110,000	Initial gap – R99,000
Poor	R1,000	+ 10%	= R1,100	R110,000 – R1,100 = R108,900
Poor	R1,000	+ 20%	= R1,200	R110,000 – R1,200 = R108,800
Poor	R1,000	+ 100%	= R2,000	R110,000 – R2,000 = R108,000
Poor	R1,000	+ 1000%	= R11,000	R110,000 – R11,000 = R99,000

At the outer limits of what might be achieved, if B’s income grows twice as fast as A’s in an exceptionally prosperous country with 10% annual growth, it will take 26 years for B to reach A’s initial income but by then A will be earning about R1,200,000 and the gap will have increased to a massive R1,100,000. At such rates, the relative gap closes, but very slowly.

A’s relative income would decline from 10,000% to 1,200% of B’s over the 26-year period. It would take many years for the nominal gap to start closing and 53 years for their incomes to equalise.

The only real world way to prevent the gap from growing is stagnation or depression (‘negative growth’) as in Zimbabwe. Nominal income gaps close only under conditions of extreme destitution. A dream world is conceivable in which people obsessed with perverse desires to destroy the rich regardless of what happens to the poor – which is a surprisingly common aberration – fantasise about the rich getting poorer, the poor getting richer and the economy growing.

The rich get richer and the poor get richer faster
The income gap fallacy is usually accompanied by the widespread notion that there is more inequality and poverty in freer economies where governments redistribute less. Fortuitously and counter-intuitively differences in levels of equality of condition differ only slightly between free and unfree economies, and there is much less “abject poverty” (destitution) in freer economies.

To the minimal extent that there is a difference, free economies are characterised by slightly more equality. Of greater significance, is that the poor have much higher living standards in free economies. They seem to know something social scientists don’t know. They know precisely why it is best to be poor in rich countries where they benefit more from personal liberty than from plundering the rich.

If the income gap is irrelevant at best and absurd at worst, what should policymakers be concerned about? Firstly, relative incomes should be irrelevant. All that matters is whether living standards are improving for the poor and at what rate they are doing so. If governments cannot raise themselves or their constituencies above the crude Darwinian obsession with relative rather than absolute conditions, they should observe the relative rates at which conditions change. If they do that, they will find that during high rates of market-driven economic growth, the rich get richer and the poor get richer faster despite the fact that the income gap grows.


Author: Leon Louw is the Executive Director of the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Foundation.

FMF Feature Article – 22 July 2008 - Policy Bulletin / 30 June 2009