Monday, December 6, 2010

My Two Cents on Income "Inequality"

The quality of the debate on income inequality in the US is scraping the bottom, so I might as well contribute to the decline. Quite often, some innumerate journalist would quote some scary statistic about the top X percent taking home Y percent of income, while the bottom Z percent take home substantially less. But there is something missing from the discussion: a serious look at the link between productivity, growth and inequality.

If you roll back time, you will find that one of the oldest forms of wealth was livestock. If you have a cow, how long would it take before you become twice as rich on a "per household member" basis? There are some limitations to the enrichment scheme, both in the numerator and the denominator. People back then had many children, hoping some would survive to help on the farm. So you have your own progeny's growth working against the "per capita" wealth. The limitations in the numerator are well-known: the cow can only have one calf per year, some might be male or stillborn, the cow itself may die, and, even if you grow your herd, there are external factors, such as feed availability or raids by the Visgoths, the Vikings or the Vandals. Clearly, accumulating livestock wealth on a per capita basis had been a long and arduous challenge.

Jump ahead a few centuries. Now imagine you're an intrepid merchant loading up sacks of spices on your caravel docked at what might still be considered an exotic location. You sail off for the homeland, hoping to sell the spices at a nice mark-up. The treacherous trip around Cape Good Hope might take a couple of years. You might also run into Berber pirates: again, accumulating wealth, even with good tail winds, took a lot of time.

If you fast forward again a few hundred years, you might see that a series of inventions (such as steel and the steam engine) had given birth to a new boom industry: rail roads. Laying track is substantially more capital- and labor intensive than breeding cows but, once completed, the lines started generating untold, for the day, riches for the tycoons of their time. So technology enabled faster accumulation.

And, if you fast forward to last week, the founder of a three-year old web site called Groupon walked on a $6 billion offer from Google. Just to put it in perspective with our livestock example, live steers/heifers trade at about $1 per pound, or about $1,250 per animal based on some USDA release I just read. The gentleman founder of Groupon could have had quite a herd. It is also important to recognize that the founder is literally standing on the shoulder of giants: countless manhours of thought and labor are making his success possible: electricity, power plants, metallurgy, conductors, semi-conductors, plastics, glass, paper, and, yes, even Albert Gore Jr., father of the internet.

So what is the progression in these examples? It's the ability of technology to accelerate value creation exponentially. This means that we might see bigger winners more often. Look at the social media space, something virtually unknown five years ago. Today, Facebook, Twitter and Zynga combined are worth in the tens of billions. Are the mythical Top X% more likely to benefit from this acceleration? You bet.

My view is this: I do not mind that people make a lot more than I do so long as it is done fairly. Someone's making more than you should be a source of motivation not envy. And we should be happy that we are in an environment where people can achieve so much, so quickly. Talk to your Eastern European friends about the gifts of institutionalized equality. More importantly, the income growth is NOT a zero-sum game: someone creating billions via twitter did not hurt the income of the greeters at Wal-mart (but making it sound so makes a better story to sell.)