Mark Friedman

Chapter IV: Solutions: How to Reduce Inequality

It is more efficient to structure an economy so that it distributes income equitably in the first place than to attempt to redistribute income through taxation or other means. Without denying the present necessity for a progressive tax structure to redistribute income, Galbraith wrote,

For promoting equality a reasonably equal distribution of income is much superior to an unequal distribution which is then remedied by taxation. Once people have income, they have a not wholly surprising resistance to action, however righteously inspired, to remove it. And their ingenuity in defending possession is great (Galbraith 1973, 258).

Ravi Batra, in his writings, agrees. He notes that besides the difficulty in relying on the honesty of the rich to pay their taxes, tax redistribution schemes must rely on the honesty of government officials to properly distribute the funds to the poor rather than to line their own or their relatives pockets or support their favorite pork-barrel projects (Batra 1973, 28). Such corruption is particularly an obstacle to redistribution in Third World countries.

A recent study estimated the marginal efficiency cost of redistribution (MECR) for various redistribution schemes (Ballard 1988). If the condition of the poor is improved by one dollar, but the cost to the rest of society is more than a dollar, the excess cost is the MECR. Three schemes were described, a universal cash grant, a notch cash grant (in which only the poor are targeted, and richer classes are taxed higher), and a wage subsidy. The latter would be most similar to what has been proposed in this paper, a high minimum wage. (Presumably this would involve some degree of subsidy, as a few in society would not achieve the level of productivity worth at least the minimum wage. However a progressive society would minimize the number of such people with effective education and health care systems and a sound social structure.) The highest MECR was for the universal cash grant. Under varying conditions, the cost was estimated between $.519 and $2.03. The notch grant had the second highest cost, between $.105 and $.459. However the MECR for wage subsidies was near zero or below, suggesting it is the most efficient means to redistribute income.

Batra has devised the following system for distributing income, based on the principle of atiriktum. In the following formula A stands for atiriktum, NNP for net national product, L for labor force, and w for the real wage required for the minimum standard of living. Recall that atiriktum has been defined as the surplus remaining available to society after at least the minimum wage, or the minimum standard of living, has been supplied to all. Then

A = NNP – wL

If TPj is the total product of the the individual who contributes more to the economy than the minimum wage, then the incentive income for that person could be given by the formula where n is the number of individuals producing more than w.

Batra offers as an example a simple economy with a labor force composed of five people (L = 5). Their current monthly income in rupees is 100, 200, 300, 1000, and 1500. (That brings NNP to 3100.) But 500 is require to purchase the minimum necessities. The summed TP of those earning above the minimum is 1000 + 1500 = 2500, and n = 2. A = 3100 – 2500 = 600. The incentive income for the person now earning 1000 would be 600 x (1000/2500) = 240.

The income distribution would go from (100, 200, 300. 1000, 1500) to (500, 500, 500, 740, 860).

Batra’s scheme assumes that the two wealthiest earners were earning at first according to their real marginal productivity, an assumption he admits may not be valid. As has already been mentioned, many authors, Galbraith prominent among them, stress that wages are institutionally determined and have little to do with any real measured productivity. If power relations do indeed play a roll in determining wages, setting a reasonable maximum distance between the accepted minimum and maximum becomes all the more important, as will be discussed next.

It is a basic tenet of the theory of atiriktum that there must be a relationship between the minimum and maximum wage in a society. Both psychological research and economic reasoning give evidence to this necessity. Without an upper limit the power of incentives is weakened, as the ever-present possibility of more encourages demand for more. The resources of the economy are strained, and inequality is increased.

The wise have always known that more material accumulation will not necessarily make a human being happier. In fact research shows that people in poor countries generally consider themselves about as happy as people in materially affluent countries. What makes a difference in personal satisfaction is a person’s relative economic position in society. Those who are relatively better off report that they are happier than those that are relatively worse off. (Daly and Cobb, p. 86)

The economist Pigou made a similar observation: “If a man who had all his life slept in a soft bed was suddenly compelled to sleep on the ground under the sky, he would suffer greatly; but does a man who has always slept on a soft bed enjoy his nights more than one who has always slept under the sky? Is it certain that a hundred Rolls-Royce cars in a Rolls-Royce world would yield a greater sum of satisfaction than a hundred dog-carts in a world of dog-carts?” He went on to doubt “… whether substantial reduction in the real consumable income of rich people, provided it were general, would, after time had been allowed for adaptation to it, appreciably diminish their economic welfare.” (Pigou, p. 84)

This reasoning shows that it is not the absolute quantity of material goods that gives satisfaction. It is one’s position in relation to one’s peers that counts. If there is an extremely wide range of income disparity in a society, it will take much larger increments of incentive to induce greater productivity, particularly in the higher income level. However, if the range is narrow a smaller amount will have a greater effect in changing the person’s perception of her position in society; the efficiency of incentive will be increased. The dictum of Prout that there must be a maximum as well as a minimum wage, and that society should constantly strive to narrow the difference between the two makes good economic sense.

There is growing acceptance of the idea that there should be a relation between the minimum and maximum wage given in a company or industry. Writes Galbraith, “The most forthright and effective way of enhancing equality within the firm would be to specify the maximum range between average and maximum compensation (1973, 260).” Such policies are already in place in many European and Japanese firms, and in a small but growing number of American firms.

But in order to have a greater impact on inequality in society minimum and maximum wage rules need to be enforced society-wide. This proposition is also growing in popularity as is evidenced by a soon to be published book by Sam Pizzigati with the title The Maximum Wage. The economists Herman E. Daly and Ravi Batra have also championed this principle.

The question remains as to how to set the maximum standard. (Setting the minimum wage is easier — it must be at or above the family poverty level.) If attempts at setting the optimal individual wage as was described in the previous section became commonplace (assuming personnel managers became skilled in the practice) statistical studies could determine the interval between the minimum and maximum wages in these firms, and use these results as guides for the rest of society.

Others would not have patience for such a drawn-out process that could have dubious results, even if the conditions for gathering the data were in place. Many are rallying behind what Pizzigati has coined the Ten Times Rule — the maximum wage should be no more than ten times the minimum. Batra first proposed this rule in the 1970’s and defends it forcefully. He argues that attempts at finding optimal levels of inequality have produced unsatisfactory results, and are unlikely to do any better in the future because of difficulties in measuring utilities and differences in criteria. The practical problem of inequality cannot wait for useless theoretical constructions. He writes,

As a practical guideline, the decimal scale for income distribution is unimpeachable. It is simple, and not riddled with loopholes. Given the will of the people and governments, it should not be difficult to enforce it. Let us not waste any more time and proceed to implement it (Batra 1979, 32).

It will be argued by conventional economists that imposing maximum wages will introduce artificial distortions into the marketplace which will impede its functioning. While such a change will certainly not come without some difficulties, particularly in the beginning phases, the idle, unproductive concentration of great wealth in few hands brings far greater distortions into the economy. Aside from the waste already discussed, it distorts the nature of the goods demanded from society. The tastes of a few disproportionately, but without moral or economic justification, dictate what is produced. The needs of the masses may be left wanting. Certainly such a situation cannot describe a well-functioning market.

Conclusion

It has been shown in this paper that a degree of inequality serves society by increasing the fruits of productivity available to all. But inequality must be limited or any benefits will be lost. The implementation of a maximum wage would effectively remedy excessive income inequality.

Bibliography

Ballard, Charles L. “The Marginal Efficiency Cost of Redistribution.” The American Economic Review 78 (December 1988): 1019-1033.

Batra, Raveendra N. Prout and Economic Reform in India. Delhi, India: Khosla Publishing House, 1979.

Braun, Denny. The Rich Get Richer. Chicago: Nelson-Hall Publishers, 1991.

Daly, Herman E., and Cobb, John B., Jr. For the Common Good. Boston: Beacon Press, 1989.

Friedman, Mark. The Progressive Utilization Theory of P. R. Sarkar. Unpublished paper.

Galbraith, John Kenneth. Economics and the Public Purpose. New York: The New American Library, 1973.

Kerbo, Harold R. Social Stratification and Inequality. New York: McGraw-Hill Book Company, 1991.

Leibenstein, Harvey. “Aspects of the X-Efficiency Theory of the Firm.” Bell Journal of Economics. 6 (Autumn, 1975): 592.

Lekachman, Robert. A History of Economic Ideas. New York: McGraw-Hill Book Company, 1976.

McConnel, Campbell R., and Brue, Stanley L. Contemporary Labor Economics. New York: McGraw Hill Book Company, 1989.

Maslow, Abraham H. Eupsychian Management: A Journal. Homewood: Richard D. Irwin, Inc., 1965.

Mishan, E. J. Welfare Economics. New York: Random House, 1969.

Mishel, Lawrence, and Franklin, David M. The State of Working America, 1990-91 Edition. Armonk: M. E. Sharpe, Inc., 1991.

Nickson, Jack W., Jr. Economics and Social Choice: Microeconomics. New York: McGraw-Hill Book Company, 1975.

Osberg, Lars, Economic Inequality in the United States. Armonk: M. E. Sharpe, Inc., 1984.

Pigou, A. C. The Economics of Welfare, fourth edition. London: MacMillan & Co LTD, 1962.

Rivlin, Alice M. “Income Distribution — Can Economists Help?.” American Economic Review. LXV (May, 1975): 1-22.

Robinson, Joan. The Economics of Imperfect Competition. London:  Macmillan and Co., Limited, 1934.

Sarkar, P. R. Prout in a Nutshell Part IV. Calcutta: Ananda Press, 1987.

Sarkar, P. R. Prout in a Nutshell Part XVII. Calcutta: Ananda Press, 1989.

Scitovsky, Tibor. Welfare and Competition. Homewood, Illinois: Richard D. Irwin, Inc., 1971.

Sen, Amartya, Welfare Economics and the Real World. Memphis: P.K. Seidman Foundation, 1986.

Sibley, Mulford Q. Political Ideas and Ideologies. New York: Harper & Row, Publishers, 1970.

The Economist 311 (June 17, 1989): 79-80.

Tomer, John F. “Worker Motivation.” The Journal of Economic Issues (June 1981): 351-361.

U. S. Bureau of the Census Current Population Reports. Series P-70, No. 22, Household Wealth and Asset Ownership: 1988, U.S. Government Printing Office, Washington, D.C., 1990.