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The Good Thing About Inequality

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It can be heartbreaking to see people go hungry. It's also hard to see so many people go without adequate shelter, health care, and education. These tragic stories represent the bad side of wealth inequality, and people across the country live them out every day. But is there a good side to inequality -- one that is less obvious than the negatives?

A look at American inequality
We know that the wealth gap has increased of late:

As another example of inequality, in the first year of recovery in 2010, the top 1% earners took 93% of income gains. That is, the incomes of the top 1% increased more than 11%, while the incomes of the remaining 99% gained 0.2%. Incomes are extremely unequal -- and the gap is only widening.

But what's the big problem with inequality? Besides the apparent social issues, The New York Times found research observing that "in rich countries and poor, inequality strongly correlated with shorter spells of economic expansion and thus less growth over time." As research goes, however, the numbers can say many things.

The positives of inequality
On the flip side, as the Harvard Business Review notes, "because inequality puts more resources into the hands of capitalists (as opposed to workers), it promotes savings and investment and catalyzes growth." The authors describe how they found a relationship where both high and low levels of inequality hurt growth, and that the optimum inequality was around the year 2000 -- or perhaps a little more unequal than that.

It's strange to think that inequality should be good for the economy. Looking at the income share of the top 1% versus GDP growth, the worst years of the Great Depression occurred after the 1% earned nearly 25% of the national share. However, bad years also occurred in the mid-1940s and early 1970s, when the 1% earned about 10% of total income:

Source: Emmanuel Saez income figures; MeasuringWorth.

The relationship between inequality and prosperity in the U.S. is fuzzy, as there are many factors that determine economic growth besides income equality.

Income trends
One definite aspect of inequality is that today, the top earners take more from wages and salaries and less from capital income than they did in the past. Whereas the top 1% of wages and salaries took home about 5% of the total in 1970, this figure was more than 12% in 2007. This also correlates with the incredible pay packages seen only in the last few decades:

  • McKesson (NYSE: MCK  ) CEO John Hammergren earns $6.3 million in salary and $112 million in stock options.
  • Simon Property (NYSE: SPG  ) CEO David Simon earns $1.25 million in salary and $120 million in stock rewards.
  • CBS (NYSE: CBS  ) CEO Leslie Moonves earns $3.5 million in salary and about $66 million in other compensation, making him the highest-paid media CEO in the U.S.
There are also other standouts: the CEOs who only take $1 in salary. Apple's Steve Jobs was famous for this, but joining him are Facebook's Mark Zuckerberg, Tesla's (NASDAQ: TSLA  ) Elon Musk, Hewlett-Packard's (NYSE: HP  ) Meg Whitman, and Google's Larry Page, among others. Whereas a pay package like David Simon's gets voted down by shareholders with a "say on pay vote," these dollar-bin CEOs further align themselves with shareholders with rewards closely tied to stock performance. For example, as Tesla struggled with cash flow in 2008 and 2009, when Musk himself "had to borrow money for rent," investors could at least comfort themselves that Musk wasn't bankrupting the company with an extravagant salary. And while HP's poor performance can't be blamed on Meg Whitman's salary, the $7.2 million severance package for previous CEO Leo Apotheker doesn't help its declining prospects.
A stronger union
With the data painting many pictures of the effects of inequality, both sides agree that it's important to maintain the sense that society is fair. While that could be accomplished in many ways, the easiest seems to be, well, actually making society fair. As the Occupy protests demonstrate, some believe society is rigged too in favor of the wealthy. However, as a Gallup survey indicates, 50% of people still believe in the opportunity for a poor person in this nation to get ahead by working hard. That's up from 38% in 1994.

If you are part of the 99%, our new free report highlights three less-than-luxurious stocks the 1% may be overlooking. Just click here to read it now.

Read/Post Comments (1) | Recommend This Article (3)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 27, 2012, at 4:43 PM, RadWriter wrote:

    Talk about malarky! First off, no one has said that there should be complete economic equality. Sure, there are rational advantages to some level of income and wealth inequality. But, as in so many things in life, there are limits that when passed, it becomes destructive. Do we really want to replicate 1926-28?

    Only in a fantasy world can one take a modest anything and turn it into an unquestioned good when extrapolated to infinity. More cash in the hands of the wealthy leads to more investment and savings? We've been trying that for three decades. Where is the savings growth? Savings has been steadily declining in the US for those 30 years. Savings was positive during the post WWII era through the 70s. It is now negative.

    One good question, I believe, is why are US CEOs paid so much more than their counterparts in Europe or Asia? Why are they paid so much more today (not merely in dollars but also in comparison to everyone else in the company) than they were 40 years ago? We might also ask why the link between productivity and reward broke down in the early 70s (in opposite directions for officers and for rank and file employees)?

    Even disregarding issues with the GDP as a measurement tool, if we examine the chart of GDP and the share of income going to the top 1%, it is clear that the economy grew faster and more reliably during the 50s and 60s when income inequality was far lower than it has been over the past 30 years. But is that causal or merely coincidental? Many changes are occurring simultaneously at any point in time. Why does the chart extend only to 2004?

    Second, finding the exception to the normal and parading it as though it were the normal is dishonest. Comparing the income distribution of the very top of the pyramid without also comparing it to the rest of the pyramid is also dishonest. Show the whole picture!

    To talk of income without comparing wealth is, if not dishonest, negligent. To talk of salary (even including capital gains) without discussing total compensation is dishonest.

    Creating shareholder value, really? We have seen separation packages in the tens of millions to billions of dollars given to departing corporate officers who tanked their companies in myriad ways. "Chainsaw" Al Dunlap was typical of a breed of CEOs who looted their companies for their own benefit through fraudulent accounting in the name of aligning their compensation with shareholder value.

    How many CEOs have failed at HP, HCA/Columbia, BP, Exxon Mobil, Ford, GM, Bank of America, Citi, etc.? These folks collect millions in pension and health care benefits, contract buyouts, etc. despite their failures.

    Economic inequality per se has never been the issue. The degree and scope of inequality are always the issue.

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