Business Is One Reason For Economic Inequality - And Also For Equality

by: Bill Conerly

Is business a reason for economic inequality, or does business reduce economic inequality? I believe the answer is "Yes."

Private business both increases and decreases inequality, in conjunction with changes in the structure of the economy, technology, social attitudes and public policy. Private business does not definitively determine the distribution of income, but it influences it.

(This article is based on my presentation in Moscow, Russia, at a conference sponsored by Carnegie Moscow Center, September 19, 2018.)

I will preface my remarks with a caution about being too focused on inequality. I care much more about poverty. For example, income distribution is far less equal in my own country of the United States than in a country such as Cambodia. Yet the poor in America have much higher incomes than the average Cambodian.

Business practices affect inequality in three different ways, through corruption, scalability, and the search for undervalued resources. I close with a story about a for-profit business helping people who have lost their jobs.

Corruption

Let's begin with a sad case in which business increases inequality and shrinks total economic activity. This is corruption.

I first studied income distribution when I was in my early twenties. As you can see from my hair color, that was a few years ago. Professor Martin Bronfenbrenner, an expert on the subject, told us that Haiti had the most unequal income distribution. This was during the rule by the Duvaliers, Papa Doc and his son Baby Doc. The inequality arose from government favors to key business leaders, such as granting monopolies and government contracts. The rich got richer, and the poor people got less for the money they spent and had fewer opportunities to earn money. The problem was not business, but the collusion between corrupt government officials and dishonest business people.

This pattern plays out over and over again. The extreme examples include the Philippines under Marcos, Indonesia under Sukarno, and today Cameroon under Biya. And other cases are abundant.

Business will be corrupt where government officials are corrupt. But where the government is generally honest, business will be generally honest. Business leaders will reflect the morals of the government and the society under which they operate.

Reducing corruption produces two good results: it increases total economic activity, while also increasing the welfare of poor and middle-class citizens.

The sad part of this issue is that I cannot tell you how to get from here to there. Take Sicily. The island has a history of corruption dating back hundreds of years. How can Sicily become more like Sweden? I don't know, but I am certain that Sicilians would be much better off with less corruption.

Scalability of Innovation

Now I turn to the greatest force generating economic inequality today: scalability, in technology and in business. Venture capitalists considering an investment in a start-up will typically ask, "Will it scale?" A simpler question would be, "If we want twice as much revenue, do we have to work twice as hard? Consider Google (NASDAQ:GOOG) (NASDAQ:GOOGL). Once it built its search engine so that one person could use it, providing the service to additional users was very easy. We say that it scaled.

My maternal grandfather was a farmer, who had about 40 hectares of scrubby land. If he had been a great farmer, he might have been able to buy more land, increasing the scale of his farming. The benefits of his great ability might be spread over 100 hectares. That would not have made him rich, but he would not have been so poor.

Now think of a scientist developing better seeds or fertilizer or pesticide. If this scientist is great, benefits could be spread over millions of hectares. The gains would mostly go to the consumers of agricultural products, with some also going to farmers using the scientific advances, but a small share of the gains would go to the scientist or the company employing him or her. That small share, multiplied by huge, global value, produces a large fortune. The scalability of the achievement increases inequality, at the same time that it makes everyone better off - scientists, farmers, and consumers of agricultural products.

My other grandfather was a clerk. He made a living doing arithmetic. If he had been a really great clerk, he might have been promoted to a manager of other clerks, helping six or seven other clerks do better work. But today a computer programmer can help millions of clerks do better work. The programmer, or his company, will gain a portion of the benefit, increasing economic inequality while the overall economy grows larger.

This concept extends to managers of organizations. A person who improves the overall performance of a large corporation, helping thousands of workers be more useful, has added billions of rubles of value to the world.

The ability of corporations to benefit from the work of their scientists, engineers and managers increases the compensation of these workers. Today in my country, very few of the wealthy people inherited their fortunes. Most of them earned their fortunes by providing great value.

An alternative view of inequality derived from older experience. In this view, we all produce goods and services, but people in power extract a larger share. That certainly appeared to be the case in feudal societies. And corrupt countries validate this view: that some of the rich stole their fortunes. But great wealth can also come by providing value that scales across the economy. Public policymakers should understand that this source of inequality is actually good.

Undervalued Resources and Underserved Markets

So far I have talked about business increasing inequality through corruption and scalability of innovation. Now let's turn to how businesses reduce inequality, and this is a wonderful story. Businesses use resources, including land, raw materials and labor. Businesses are always alert for undervalued resources, which means resources that can be bought cheaply. When businesses can find people willing to work at low wages, they will hire them. As businesses compete for these low-wage workers, the wages and working conditions improve.

After 1945, Japanese labor was cheap. American companies imported many products from Japan, and this use of undervalued labor led to higher wages for the Japanese. The same process pushed wages up in Hong Kong, Korea, Singapore and Taiwan, the "Four Tigers" of Asia. Poverty was greatly reduced in these countries.

The greatest example of improved conditions for poor people is China. Hundreds of millions of people lived on dreadfully low incomes under communism. After the country opened up for business, production increased and poor people did better. When international trade increased, the poor did much better.

China's neighbors learned the process, and growth has helped poor people across Asia, especially in the poorest countries of southeast Asia.

We define extreme poverty as living on less than $1.90 per person per day. That's about ₽132 person per day. The number living in extreme poverty has dropped by over one billion people in a 30-year period. This is the greatest reduction of poverty in the history of the world. Let me repeat that: The greatest reduction of poverty in the history of the world.

This wonderful achievement was not the result of a government initiative. The Government provided roads, a justice system, and other necessary processes, but it was private efforts that made the difference. Adam Smith had the great insight that widespread benefits come from people in business pursuing their own self-interest. And this alleviation of poverty is a tribute to the power of self-interest, pursued honestly.

At the same time that companies are looking for undervalued resources, they also look for underserved markets. We find private companies bringing inexpensive clothing to poor people. Cheap mobile phones. And pay attention to India, where the country's richest man is offering extremely cheap mobile calls and data. Poor people's incomes are rising, and their ability to buy goods is increasing.

Small Initiatives

Finally, I will close with one illustration of ways in which profit-seeking businesses earn a profit and reduce inequality at the same time.

In the United States, people who are laid off from their jobs receive unemployment compensation equal to about half of their wages, for a period of six months in most cases. Businesses are taxed to support this system, and the taxes reflect how much each company adds to the costs of the system. Each company is taxed based on the number of people they lay off, their wages, and how long it takes these people to find another job.

Years ago I researched this system and discovered a few examples of organizations helping unemployed people find new jobs more rapidly. My research was incorporated into a company called NextJob, which is a for-profit company helping people find jobs. (I am not affiliated with this company.) Some of their fees are paid by companies that laid off workers, who keep their tax bills low by helping their former employees find new jobs quickly. Another source of fees is banks that have lent money to people who then lost their jobs. If they can find new jobs quickly, they can pay back the banks.

This company is helping workers stay in the middle class. It's helping employers keep their tax costs down, helping banks collect on the loans they have made. And NextJob itself is making a profit.

Conclusion

Profit-seeking businesses are a part of the evolutionary process of the economy. At their best, they find ways to improve the world, by innovation in technology and business processes, through using undervalued resources and offering products to underserved markets. In an honest society, profit-making businesses help the poor as well as the rich.