PRINCIPLES OF INEQUALITY

by Dr. Hans Sennholz
Many Americans are unhappy about the growing inequality in individualincome and wealth. Corporate profits are rising, executive salaries aresoaring, but the wages of most workers are barely moving. Even employeeswith technical skills are feeling squeezed and college graduates arefinding it difficult to make a fitting beginning. It is not surprisingthat politicians, in search of a popular issue, are adding theirinterpretations and recommendations. On the left, they are criticizingcorporations for unpatriotic behavior, exporting American jobs in searchfor ever higher profits. On the right, they are condemning corporationsfor hiring illegal aliens who come to the United States and labor in theunderground economy. Both sides are waving the American flag and fillingthe air with political malice and strife.

Men are made by nature unequal. Surely, to assure social peace, all menmust be equal before the law and have an equal right to the protection ofthe law. But they do not have equal ability and productivity and,therefore, do not have equal incomes. A political order that endeavors tocreate economic equality by force is unnatural; it is destined toself-destruct in destitution, discord, and strife.

Individual incomes always depend on a person's productivity in renderingservices to others. Most individuals merely earn compensation for servicesrendered, commonly called wages, salaries, fees, or honoraria. Thriftyindividuals may enjoy also interest income on their savings. Andenterprising individuals may even reap pure profits which flow fromcorrect anticipation of future needs and supplies, future costs andprices, in short, future states of the market. In a welfare state manypeople also enjoy transfer benefits forcibly taken from taxpayers. Morethan fifty million Americans presently draw such payments from theirfellow countrymen.

In a free market economy individual differences in income may be veryvisible although rather limited in numbers. There are few corporateexecutives, artists, and authors with million-dollar salaries andhonoraria every year. There are not many investors enjoying million-dollarinterest payments on their holdings. But there always are some youngentrepreneurs who manage to foresee important market changes and thereforereap million-dollar profits. But all such differences pale in significancewhen compared with those caused by man's choice of social and economicorganization. Depending on his perception of the nature of man and on hisunderstanding of social and economic cooperation, he may choose to live ina great variety of economic orders. Some are highly productive yieldinghigh standards of living for all; others are barren and poor condemningmembers to short and wretched lives. According to The Economist's World inFigures, 2006 edition, the people in Luxembourg, for instance, areenjoying an annual gross domestic product (GDP) of $55,500 per year, inNorway they are producing $37,910, and in the United States $37,750. Incontrast, the people of Somalia subsist on $440 a year, in Sierra Leone on$530, and in Malawi on $590. The life expectance in the latter is aboutone-half of that in the former.

Such country differences began to develop some 300 years ago when inWestern Europe a new social and economic philosophy began to removeinstitutional barriers to economic development. The laissez-fairephilosophy of Adam Smith, David Ricardo, and many other authors inEngland, France, Germany, and the United States replaced old doctrinesthat branded economic freedom and acquisitiveness as immoral and advocatedlegal barriers to economic inequality. The new philosophy set the peoplefree to remove these barriers and pursue their economic interests.Economic production immediately accelerated and standards of livingincreased visibly. Unfortunately, occasional relapses to old thoughts andpolicies interrupted the economic progress, and many countries that havenever been exposed to the light of economic freedom continue to linger indismal poverty.

At the present, the light is spreading slowly throughout many parts of theworld, even where the political structures continue to be authoritarian.China, Vietnam, and India seem to be leading the way. But economicstagnation is holding many other countries in its grip as new productionbarriers are being erected to reinforce the old. Business taxes may beraised and business capital may be consumed not only by the poor and needybut also an ever-hungry bureaucracy. There is economic stagnation inFrance, Germany, Italy, Japan, and Switzerland. In many countries someeconomic pursuits do prosper while others stagnate or even decline.

Economic progress builds on the formation and investment of businesscapital which raises output and income. It may do so with new methods ofproduction and new inventions or without altering the mode of production.Market pressures then divide the new income between the entrepreneurs wholead the way and the suppliers of the factors of production. In the shortrun, the entrepreneurs may be the beneficiaries but, in the long run,production adjustments always eliminate the entrepreneurial profits andmake workers the primary recipients. In the United States and all othercapitalistic countries they have been the main beneficiaries ever sinceobstacles were first removed and new investments were made.Short-run syndromes of change now are permeating the American economy.Some executive incomes are counted in the millions of dollars, but thewages of many workers are barely keeping up with the rate of inflation.And once again, old explanations are making their appearance, findinggrievous fault with such profits and the profit motive. These criticsfavor a more progressive tax system that would reduce the gap between therich and the poor. They would reform and expand social welfare, inparticular the health care system and the public pension system. And aboveall, they would restructure the education system in which only threepercent of students at top colleges come from the poorest quarter of thepopulation. Unfortunately, such reforms not only would boost the powers ofthe political reformers but also raise the costs of labor and weaken thelabor market. They may even increase the rate of unemployment, especiallyof unskilled workers. There would be more beneficiaries of SocialSecurity, Medicare, Medicaid, and generous scholarships, but socialmobility would suffer another blow. In a heavily taxed and regulatedeconomy it is much more difficult for a poor worker to advance in income,wealth, and position than for a wealthy person to remain wealthy.

Globalization is outsourcing some white-collar jobs, which is more gristfor the mill of the reformers. Their eyes are glued on executive incomes;they are blind to policies that have undesirable consequences, policiesthat may even give rise to the very effects which they deplore. Therecannot be any doubt that the monetary policies of the Federal ReserveSystem greatly affect not only the purchasing power of the U.S. dollar butalso individual income and wealth. When economic activity slowed down in2002 the Fed immediately slashed its discount rate to 11/4% and then 1%,the lowest in 45 years. Resting on the Fed rate, all other interest ratespromptly plummeted to levels far below true market rates, which inducedsome investors to search for higher rates and higher incomes abroad. Withthe discount rate at 1% and all other rates not much higher, and withforeign rates at double and triple levels, it is only natural that manyinvestors seek higher returns abroad. They may even have to leave thecountry in order to meet the competition that is now abroad. Surely, thedriving force is the investor's profit motive, but it is the FederalReserve policy that creates the foreign opportunities.

In a free and unhampered economy the short run is a period of readjustmentto a changing market condition. Entrepreneurs and investors react quicklyin order to maximize their profits. When legislators and regulators, forany reason, erect their barriers, they obviously delay the readjustment;labor productivity and wage rates may stagnate or even decline.Legislation and regulation may turn a free market economy into a commandeconomy with rigid income and class structures. Massive deficit spendingmay pave the way. At the present, the federal government is sufferingbudget deficits amounting to hundreds of billions of dollars, which arereadily financed by the Federal Reserve System. Surely, the Fed does notdirectly purchase new Treasury I.O.U.s; it merely enables American andforeign financial institutions to buy them.Extraordinary expansion of money and credit gave rise to phenomenal tradedeficits, $618 billion in 2004, some $700 billion in 2005, and probablyhigher yet in 2006. Suffered by any other country, such deficits wouldsoon cause the national currency to flounder and thus call an early haltto the deficits. But the U.S. dollar is the primary reserve currency ofthe world, which persuades many foreign creditors to cling to theirdollars or invest them in dollar claims. According to some estimates,foreign banks and investors are holding some $9 trillion of U.S. paperassets. They are owning some 43% of U.S. Treasuries, 25% of U.S. corporatebonds, and 12 % of U.S. corporate equities. Dollar cash holdings as wellas U.S. Treasury obligations obviously are no investments in businessfacilities, such as corporate stocks, bills, notes, or bonds, which wouldraise labor productivity and wage rates.

Many Americans undoubtedly are unhappy about the growing inequality inindividual income and wealth. They are guided by simple motives andbeliefs in the equality of man, which theologians, philosophers, andstatesmen have featured since the beginning of time. Thomas Jeffersonaffirmed it in the Declaration of Independence: "We hold these truths tobe self-evident, that all men are created equal, that they are endowed bytheir Creator with certain unalienable Rights, that among these are Life,Liberty and the pursuit of happiness." No matter how we may read thisdeclaration, it does not dwell on any equality of income and wealth. Onthe contrary, it speaks of "unalienable rights" in "the pursuit ofhappiness," which undoubtedly comprises also the right to pursue incomeand wealth.

When Thomas Jefferson wrote the Declaration Continental Congress hadlittle money and poor means of obtaining more. The financial situation wasrather precarious. Congress then authorized many issues of paper dollarsand the states followed suit, issuing their own. By the end of the war,they were "not worth a Continental." Surely, the current situation differssignificantly from that of the American Revolution, but it also resemblesit in several important aspects. Then and now the political authoritieseagerly issued paper dollars that lost some of their value every day. Theeconomic maladjustments which the issues brought about created countlessopportunities for knowledgeable entrepreneurs to make the neededreadjustments. While labor productivity and income stagnated or evendeclined, business opportunities and profits actually soared.

The old order always changes, yielding to the new; but many economicchanges merely reflect variations in monetary policy and their inescapableconsequences.

Editor's Note: Dr. Hans Sennholz is president emeritus of The Foundationfor Economic Education (FEE) in Irvington, NY. His essays and articleshave appeared in over 36 major German journals and newspapers, and 500more that reach American audiences. Dr. Sennholz is also the author of 17books covering the Great Depression, Gold, Central Banking and MonetaryPolicy. You can write to him at this address: hans@sennholz.com