I have heard this sort of claim quite a bit from friends in recent months:
World's 100 richest people earned enough in 2012 – $240bn – to end world extreme poverty 4x over #inequalityfacts
— Max Rashbrooke (@MaxRashbrooke) September 18, 2013
Doesn’t that sound grand – if the richest 100 people in the world gave up a quarter of their income then SLAM poverty gone. Ez.
However, this isn’t quite right. In fact it is very much not right.
Instead of thinking about quantities of paper money, we need to think about the underlying claim on real goods and services this presupposes – what exactly changes when we shift income this way.
Cut the income of the wealthiest and they will invest less and buy fewer nifty leisure goods (say boats). Give this income to the poorest in the world (if that is possible, as in many of those cases people are stuck under a corrupt regime trying to extract anything) and they will demand food, water, and clothing.
And here is the little secret economists keep trying to make public, prices will change. Without reference to a “set” of prices, income comparisons make no real sense. (Note: For those who will note it, changes to labour supply would also occur in all of this, the wage is a “price”).
When I did the series on tax, especially here, I was trying to point out that if we try to do “large” changes to the structure of an economy, we are going to have much larger sets of unintended changes – many of the simulation and structural models economists use, even with all their complication, can often only sensibly discuss “small” changes in tax and benefit structure. Trying to use a naive estimate (note this isn’t an insult, it is a technical term for modeling in the way suggested by the twitter quote) struggles even more with these changes in prices and the real values of incomes.
Many people who believe that we can take money off the rich to feed the poor simultaneously believe we are “stretching the limits” of the earth’s ability to produce food and other goods and services (such that the ‘costs’ of making more of these necessities will rise strongly if we aim to boost production significantly). These two views implicitly contradict, and we can only understand and try to measure the true trade-off with an honest view of the change in prices!
Now don’t get me wrong, income transfers should still change the underlying production and claim on resources! But how do they help? By increasing the relative return (in terms of goods and services) for the thing the poor desire, and by decreasing the relative return for those who create boats and handbags and the such.
It is also a balancing act though – by trying to lower the income of those who do invest, we also reduce capital investment overall. We change its composition and its level. Furthermore, when we provide an endowment of income we change the incentive to supply labour. This requires a view on societies underlying ability to produce, the underlying “production frontier” that exists, the way the “production frontier” moves, and the way relative prices and endowments will adjust as a result of these policies. This is much more complicated – and also much more fundamental to actually understanding issues of inequality, opportunity, and capability – than what Max’s arithmetic example stated in the above tweet.
And I believe we have heard what this is before – it is the equity-efficiency trade-off from redistributing goods and services. What do you know!
Note: This is not a criticism of Max – it was just his post I spotted that helped bring up the issue. I see this mistake happen CONSTANTLY, it can even be done inadvertently by economists I take incredibly seriously and find very insightful:
It would take only $175B/yr to bring every poor person in the U.S. up to the poverty line: http://t.co/P9tLNTOEk9
— Noah Smith (@Noahpinion) September 25, 2013
But it is still a relatively fundamental error.
Sidenote: The World Bank discusses why their focus is on alleviating poverty rather than focusing on inequality when it comes to development economics here.
Update: Dr Phil of Economics notes that, when it comes to global poverty, it is the messiness of institutions that is the most relevant issue – beyond what is described here:
@TVHE Identifying income/wealth inequality is the easy part. Reforming corrupt institutions is the tough bit.
— Dr.Phil of Economics (@DrPhilofEconomi) September 26, 2013