Why there is economic and social inequality

“The rich are getting richer and the poor are getting poorer”. It is a phrase as old as mankind and, therefore, most of the time it has not been true. However, for some years now we have had the feeling that it is more successful than ever.

Is the world more unequal now than it was, say, twenty years ago?

Yes and no. If we refer to our world, the Western world, the answer is yes.

If we are referring to the planet, the answer is no. This can be seen in the famous “elephant curve”:

Illustration 3 graphics by UGO COLOMBINO – University of Turin, Italy, and IZA, Germany. Explanation at https://www.vox.com/policy-and-politics/2018/2/2/16868838/elephant-graph-chart-global-inequality-economic-growth

Basically what it indicates is that the poor in poor countries (0 to 70% percentiles) have seen their incomes grow considerably, by 40 to 80%. Less inequality.

But the lower and middle classes of the developed world (80-90% percentiles, because the European poor are poor by European standards, but rich compared to the rest of the world) have seen little improvement.

And the richest, at the 99th percentile and above, have seen their incomes skyrocket. In fact, there are studies as of 2016 that show how the horn shoots even higher so that the richest percentile in the world alone takes 27% of the wealth created.

Therefore, in developed countries, the gap between the average citizen and the wealthy has objectively increased. So much so that practically the entire ideological spectrum admits that inequality has reached worrying levels.

The poor white American Trump voter, the Brexit, or the rise of populisms are direct consequences of the low wages and the damaged social elevators that characterize the social gap.

But to what is this inequality due?

A conspiracy of the elites? The Bilderberg Club? The collapse of democracy? Something intrinsic to capitalism?

I’m afraid the truth is much more prosaic. Let’s start…

It’s getting cheaper and cheaper to produce

It is becoming cheaper and cheaper to manufacture a given product. The production of companies is limited by demand, not by the limits of personnel or machinery. The marginal cost (what it costs to produce an additional unit) is, more and more often, very low. The companies need few employees and have a large production capacity at a standstill. Digitization is quietly shedding jobs. The fewer jobs there are, the less bargaining power employees have. The price of products goes down, yes, but that doesn’t make up for the fact that wages are not being paid.

Manufacturing in emerging countries

Labour-intensive products have been produced in emerging countries for years. This has benefited countries such as China, India and Brazil, which have been able to turn millions of citizens into the middle class. Instead, Europe and the US have traded jobs for cheap goods, impoverishing a large part of their middle class.

Less demand

Partly because we already have almost everything we need. Partly because wages are low. Real estate is expensive and a large part of the salary is spent on housing. Inevitably, low wages equal low demand.

Products that are replaced by software

Historically, the marginal cost increased proportionally to the production. But many products are being replaced by products with zero marginal cost, for example, alarm clocks are replaced by an app. The app costs a lot of money to develop and maintain, but it works the same for a hundred users as it does for a thousand. That is, if there was a demand for a million alarm clocks, that demand is now covered with a small program.

Many services are free: car navigator replaces maps or tomtom, Google replaces an encyclopedia, Duolingo replaces a language academy, Google Meet replaces a trip, and so on.

It’s good for the user, but overall a lot of money disappears from circulation and that money will no longer go into people’s pockets.

Perfect markets

The perfect market is one in which the buyer has all the information and gets the best possible price. No vendor has artificial barriers to entry. A nightmare, for a very simple reason: when there is total price transparency it is almost impossible for a company to generate margin. No margin, no money for innovation.

The fact is that part of our economy has become a “perfect market”. Thanks to the Internet, especially Amazon, you can have a lot of information about a product and you can know the cheapest place on the planet where to get it. This way it is almost guaranteed that prices will not go up or even down. But that causes deflation, which is a problem. It also favours large companies, which have advantages of scale.

Platforms such as Google, Amazon,… replace intermediaries such as shops or travel agencies. Intermediaries have marginal costs proportional to their turnover, platforms have marginal costs that tend to zero.

The digital world generates services, but not jobs or money

The digital world is the new America. A continent to explore with thousands of opportunities. But their exploration and exploitation do not require the manpower needed by the new real worlds, nor does it generate similar wealth. Getting big billings on the Internet is not easy. The trend is free or small monthly fees. To weigh on the economy companies need to multiply them by millions of users. For example, the future of the press is in its digital version, no one doubts it. Until recently there were thousands of newspapers making a decent living and maintaining staffs of dozens of journalists. How many will be able to survive digital-only? Only a few leading publications will likely succeed in establishing a subscription model: global dailies such as the New York Times or El País, a handful of national titles and a couple of newspapers per region for local information. The rest will have to fight for the meagre billings that Internet advertising gives and will be able to afford very few salaries. As a user, with the Internet, I can access an exorbitant amount of information for a very small cost, but in exchange, the press moves much less money and personnel than thirty years ago.

I don’t mean to say that digital doesn’t move money. Google or Facebook show that huge amounts of money are being managed. Together, they account for about a third of the world’s advertising revenue, some $200 billion (see figures at Statista). However, together, they do not even have 180,000 employees. On the other hand, the other two-thirds of the survivors of more traditional advertising include all the employees of television, newspapers, magazines and radio stations in the world. It is difficult to know how many there are, but certainly a lot more than 180,000. To compare the jobs generated by big tech with traditional industry, the construction of the Three Gorges hydroelectric dam in China cost $25 billion and employed some 250,000 people, i.e. roughly ten times more employees per million invested.

Of course, the Internet is constantly creating new services that cover unsuspected needs, but it does not seem to have the capacity to absorb the surplus-labour of what it makes obsolete.

The vicious circle of money creation

We have seen that money is created mainly from credits issued by commercial banks. If I’m a low wage earner, I’m hardly going to ask for a big loan.

Most of the new economy that is being created is digital and requires much less investment than that needed for infrastructure companies. Fewer credits.

The money in circulation is proportional to the debts to the banks. Less debt, less money. Less money, lower wages for people.

Certainly, to alleviate the problem, central banks are injecting huge amounts of money into the economy, but it ends up mainly in stocks and real estate, where it is tied up, not in the productive economy.

Why Technology Deflation Leads to Inequality

So the main problem in my opinion is that technological improvement has led us to an economy with two worlds: a deflationary one, the real economy, and an inflationary one, investment.

Technology multiplies and cheapens the services it gives us, but our perception, in developed countries, is not one of enrichment. At the end of the month, we have to pay for a flat that is not subject to deflation with a salary that actually is.

At the same time, those who have a well-functioning business can expand it globally and earn huge amounts of money. Those who have money left over, either through merit or inheritance, can invest it in real estate and the stock market, which are rising almost constantly, and earn more every year.

All this would not be a problem if new markets and new needs were created. They would reabsorb idle labour and wealth would be shared.

But our capacity for innovation seems to be quite limited lately to the Internet and, as we have seen, digital doesn’t move money.

That’s why we are the way we are.

References and to learn more:

Income inequality