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  • Writer's pictureRohan Bhatia

The Upsides of Inequality

Disparity between people in society of course has its downsides. In places that have more extreme levels of economic inequality - social effects such as increased crime and worsening family outcomes like divorce tend to also deteriorate. Across the political spectrum, liberals and conservatives have come to acknowledge this. Yet what does often get overlooked are the tangible benefits of inequality - especially the economic advantages that it creates. Meritocracy - which lies at the heart of the capitalist society most of us inhabit - holds a certain level of inequality at its foundation. After all, without disparate economic outcomes - what motivates one of us to work harder than another? What drives us to become productive agents?

Most noticeably, the largest advantage of inequality in the economy is what economists often refer to as the ‘incentive effect’. If an economic agent (like you or me) works harder, more efficiently and smarter - then as a consequence they should be rewarded with a higher wage. That is the fundamental premise of the capitalist economy. If you can do something better than another - you deserve to be adequately compensated. This promise of a potential higher wage is essential to encourage extra effort and productivity. And on a macro scale, higher worker productivity leads to overall greater national output which means more goods and services available for us all - at cheaper prices.

Suppose you and your friend, Phil, both work at a tissue box factory. Your employer makes it clear that you will both be paid $20 per hour for your work. It quickly becomes apparent that you are making harder and smarter than Phil - and as a result you can make 50 tissue boxes per hour, whilst Phil only makes 25. Clearly, you are twice as productive as your friend Phil. In a functioning capitalist economy with decentralised wage bargaining, you should be able to approach your employer and ask to be paid $30 per hour instead of $20. Assuming your employer accepts this request, Phil will quickly start noticing you earning more money than him. And guess what? He’ll now have an ‘incentive’ to work harder and produce more than 25 boxes per hour in the hope of receiving a pay raise himself. Let’s examine this scenario. At the end - all three parties benefit. You are earning 1.5x more than you previously were, and the employer’s factory is now producing more tissue boxes which it can sell for a profit. Yet what should be made clear is that all these benefits were driven by the ‘incentive’ that you had to work harder and earn a higher wage. Inherently, this did create inequality - you started to earn 1.5x more than your friend Phil. Yet this began the cyclical effect of driving Phil to be more productive and start producing more boxes himself - likely also leading to his ability to ask for a pay raise.

Alternatively, suppose your request to lift pay was rejected due to the need to maintain ‘equality’ in the workplace. You would feel cheated. Why put in all that extra effort if you could just try half as hard and earn the same amount of money. So instead, you walk back to the factory and pull out your phone, scroll Tiktok, Twitter and Facebook for most of the hour and end up only producing 15 boxes per hour. Overall productivity has been suppressed, and in fact, the employer feels the full brunt of this equality effect as they will have less boxes to sell and profit off.

Beyond just the ‘incentive’ effect that is created for individual employees, it remains the single most important factor driving entrepreneurs. Hence, inequality is absolutely required should we strive for an economy that continuously innovates and raises the quality of life for its citizens. At the heart of entrepreneurship lies a fundamental risk - you are putting forward an impressive investment (whether in the form of capital or time) with the hope that eventually your business will reap rewards. But if the potential reward of profits and wealth didn’t exist - why would entrepreneurs take a risk? If all businesses were equal and earned an equal income - why take a huge risk in innovative tech when you can just open a local takeaway shop. You’d definitely be putting in a lot less capital and time.

If we want our societies to benefit from the innovations of companies like Apple, Microsoft, Tesla and Amazon - we must provide the economic structures that allow them to reap the rewards. Inequality is hence a natural part of this wider capitalist structure which motivates risk-taking and not only generates wealth for the businesses taking part - but helps embed values of growth and innovation into our economies. Today we enjoy iPhones and iMacs and Windows Computers and electric vehicles - not because of government-mandated equality, but rather because entrepreneurs like Steve Jobs, Bill Gates and Elon Musk had massive potential rewards if their highly risky projects caught wind. Jeff Bezos and Elon Musk remain the richest individuals in the world not necessarily from a force of evil but rather because they have remained the best two entrepreneurial minds of the last decade.

Inequality may invoke envy and jealousy - but that is not the fault of the system; it’s a fault of the citizens that inhabit it. Itself, inequality is an in-built feature of the capitalist system we admire and the same system which has grown our quality of life so substantially.

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