Redefining Inequality

I never thought about “inequality” itself. To remove confusion, think of the “rain” and the “lake”. How many of you thought of “water” when thinking of both? Water can have so many properties; it can be sweet, salty, basic, acidic…it can also be hard. How many thought of rain of diamonds?

The reason for showing so many possibilities is that when we think of inequality, most of us and economists in particular, think of income inequality only. Income inequality is no inequality at all. Wealth inequality is the real inequality.

Economists have largely ignored the issues of inequality. Wealth inequality was absolutely ignored (from what I know), income inequality was thought to follow Kuznets’ curve. But if wealth inequality has never been the worry of any economist, how can wealth inequality have any importance?

To understand how wealth inequality is more important than income inequality, a little thought experiment will help. The thought experiment will also serve to show what can actually be considered “wealth”.

John earns $7000 per month while Jack earns $3500. John gets taxed at 20% while Jack gets taxed at 15%. That leaves both with disposable incomes of $5600 and $2975 respectively. Now let’s say John’s father is very ill and requires to be hospitalized, that eats up $750 a month while medication takes up another $350. Since his father is ill, he had to take up residence near the hospital, which is located in an upscale portion of the city. Rent payments come to $900 while food for him and his father take up $1500 (his father is ill). On the other hand, Jack lives in a simple house by himself paying $400 for rent and spends another $350 on food. Savings:

John: $5600 – $(750+350+900+1500) = $2100

Jack: $2975 – $(400+350) = $2225

After one month, John saves $2100 and Jack $2225. That $125 difference may not seem like much initially, imagine 12 months has gone by. John: $25200 & Jack: $26300. Imagine three years go by like this, so John ends up with $75600 & Jack $78900.

Plot twist: Jack is able to afford a place of his own in the cheaper part of the city, so buys it for, say, $60000. He doesn’t need to pay rent anymore and saves on the $300 a month rent. So savings each month will be $2525 now. Starting from $(78900 – 60000) = $18900, he will overtake John in accumulated savings. (“How long will it take?” Around a decade, assuming everything rolls along as described.)

Picture this, in a decade, Jack owns a house and he has more saved up. Who of the two will have more economic power? Who will be able to have more access to different markets? Who will be better positioned to take advantage of any opportunity that comes his way?

In the end, it wasn’t income inequality, nor after-tax income inequality, nor consumption inequality that mattered. It was simply that one got stuck with some circumstances and the other did not that was the difference that led to different outcomes for both. The initial starting points were different and those led to one person ending wealthier than the other. At the end, what matters is wealth inequality and not income inequality.

Hence a thing that cause one’s economic situation to be better than without that thing can be considered to be a form of “wealth”, which is then reflected in the overall economic situation of the person as measured in monetary terms or the possessions owned.

Hence, income inequality is not very unequal, wealth inequality is the true measure of inequality.

Further reading: LA Times article on the growing wealth inequality in the US

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