In many respects, the sun is awful. It can blind, cause cancer, burn skin, dry up lifesaving ponds, scorch the Earth, and inflict much other harm. However, as accurate as those horrible facts are, we would not fare well if the sun disappeared.
Similarly, income inequality is awful in many respects, but we would not fare well if it went away. An idea has set in across America that income inequality is one of our most pressing problems. Because the real and imaginary ills spawned by income inequality are incessantly chronicled,[i] they need not be belabored here. Conversely, what is essential and positive about income inequality is rarely discussed. So, let’s sort out why income inequality is more than it’s cracked up to be.
While the point does not need to be elaborated before we delve into what is good about income inequality, it should be noted that some of its specific causes are irredeemably evil. For example, income inequality can result from theft, the government (or society) bailing someone out of an irresponsible risk, or enticing politicians to use public resources to grant special business favors. Income inequality resulting from those actions is unalloyed evil. These facts should not, however, be confused with the bogus Marxian notion that capitalists steal the labor of workers (the extent to which this exists is insignificant) or that there is something evil about making a profit.
As discussed in my blog on Wealth, wealth is not the be-all and end-all of human flourishing. On the other hand, compared to the number of problems that can be alleviated with money, those that cannot are relatively few. Consequently, wealth makes human lives less “solitary, poor, nasty, brutish, and short” than otherwise. Consequently, social norms and policies that facilitate and motivate humans to create wealth benefit human flourishing.
As with all human activities, there are dark sides to creating wealth. The news is constantly replete with examples; although many are figments of imagination, a few are real. The monumental inherent benefits of wealth creation are rarely chronicled. When a human creates something for $X that other humans value at $X + $Y, she has created wealth. When I say “value at $X + $Y,” I mean that there are other humans who would be better off if they traded $X + $Y for the creation rather than keeping $X + $Y in their pockets. People’s lives improve when they trade things they value less for things they value more, i.e., both parties are wealthier. Humans’ ability to engage in activities that serve others’ wants and needs while helping themselves is a wonder of nature. Trade is fundamentally good. The more trade there is, the more good there will be in the world. To trade, however, people must use their backs, brains, or both to produce something to trade.
Of course, the prospect of income or gain is not the only factor that motivates people to produce and/or invest. On the other hand, the prospect of acquiring significantly more wealth is a primary motivation for many (if not the vast majority) of the activities that produce wealth. Lastly, wealth funds the innovation, development, production, and delivery of goods and services that are more efficient, useful, and/or fun than the pre-existing ones. In short, wealth creation is a primary driver of human advancement and flourishing.
The simple but not obvious truth about income inequality is that it is the engine of wealth creation (prosperity). In fact, the greater the income inequality, the higher the engine’s horsepower, i.e., the more rapidly prosperity accelerates. (The extreme importance of the pace of wealth creation is also discussed in my blog on Wealth. In a nutshell, improvements in standards of living increase exponentially as the pace of wealth creation increases linearly.[ii])
Why is income inequality the engine of prosperity? People get out of bed, go to work, and push themselves to be creative and productive because doing so will significantly improve their chances of better lives. Generally, the higher a person’s motivation to work, the more she will produce things other people desire. In a free market, the more people produce, the better off they will be. For the most part, the greater the actual and potential rewards from working, the greater people’s motivation to work is.[iii] Such rewards include the pay earned for the work currently being done by the employee, the prospects of getting a promotion to a higher-paying job, the pride and dignity of pulling one’s weight, i.e., not being a freeloader, and being a benefactor for others. The higher the jump in pay from one job to the next, the greater a person’s motivation is to work hard enough to earn the promotion.
People earning more pay when they work harder have serendipitous effects on the prices of what’s available in the market. The more people produce (that is, increase the supply of things that other people want), the more downward pressure on prices and the greater the ability to lower prices becomes. As the prices of goods and services go down, more people will have money left over after buying what they usually buy. In other words, people become wealthier as prices fall. Furthermore, the more excess cash people have, the more they can afford (create a demand for) products they previously could not afford. This additional demand provides a reason for people to start new businesses or expand existing businesses, thereby creating more jobs (i.e., opportunities for people to be more productive).
The creation of more jobs has serendipitous effects on wages as well. As discussed in my blog post “Investment Income and Universal Basic Income Are Not ‘Basically The Same,'” a primary reason that the wages of middle- and low-income people have been stagnant for so long is that there has been a glut in the supply of low- and middle-income people wanting to work and a dearth of low- and middle-income jobs to absorb that excess supply.[iv] (Supply in excess of demand pushes prices down.) Labor (wage) prices rise as the ratio of qualified workers per job decreases. With robust wealth creation, businesses will be started and expanded to absorb the excess supply of middle- and low-income workers. This is because having fewer qualified workers in the job queue forces employers to compete to hire scarce workers.
To sum up, the more people produce things their fellow humans value, the more wealth to invest in businesses there will be, and more jobs will be created. As wealth rises, more money becomes available to invest in existing and new companies to better serve humans’ needs and desires. The more new businesses there are, the more jobs companies will create. The more jobs there are, the higher the average income will be.
As you should now see, wealth creation enables a virtuous cycle. The motivation to work harder increases individual productivity, which creates more wealth for companies and allows the creation and expansion of businesses, which both lower prices by creating a demand for more goods and services (by freeing up the extra cash of existing workers) and create more jobs, which enables more people to work and creates more wealth. Repeat.
The preceding paragraphs discussed wealth generation from an economy-wide (“macro”) perspective. Let’s now turn our focus to wealth creation from an individual company (“micro”) perspective. Here, the prosperity engine’s “horsepower” is most clearly evident.
Companies must motivate their employees to work hard to create and produce. If a company’s competitors are better at motivating their employees, the less productive company will incur higher production costs and lose business to them. A primary means of motivating employees is monetary compensation. For monetary compensation to be an effective motivator, however, there must be a significant difference in compensation between one job and the next throughout an enterprise’s hierarchy.[v] If there is no difference in reward, no matter how much value an employee produces, the likelihood of employees exerting themselves on the job will be lower. On the other hand, the extra work that people will put in to reach the next pay level increases as the extra income pay at the next level increases; for example, a person making $7.25/hour will work harder if doing so provides a reasonable opportunity to earn an extra $2 per hour rather than just an extra $1 per hour. In these instances, greater income inequality between one job and the next higher job will cause employees to work harder than in cases of lower income inequality.[vi] For the same reasons, someone making $750K per year will be more likely to be more productive if she has a reasonable shot at an additional $200K/year than if the next level is just an extra $100K/year. The same is true for even higher incomes. Additionally, the greater the expected return on an investment, the more likely people are to invest in it. The more likely it is that the return on an investment will be reduced by taxes, regulations, confiscations, investigations, or lawsuits, the less likely investors will invest in a company. In short, the greater the gap between the rewards for producing more than alternative investments, the more likely everyone will produce more, and vice versa.
People should understand that most people give away a small portion of their wealth to serve their fellow humans. While it may be a higher percentage of their income than some wealthy people give, the per-person amount of money donated to serve public purposes is insignificant compared to the amounts of money that rich people donate for those purposes (e.g., Bill and Melinda Gates alone have already donated more than $27 billion and have pledged to give away much more for “agricultural development, emergency relief, urban poverty, global health, and education”). The only reason they can give away so much is that they created so much wealth (in addition to the wealth Bill Gates bestowed on millions of people by selling Microsoft products at prices below what those products were worth to them, and the wealth stolen from Microsoft through piracy). Unlike wealthy people, most people do not create ideas and run companies that create life-enriching jobs (financially and otherwise) for millions of employees, or produce tools that make people more productive (i.e., more valuable) in their jobs.
In conclusion, income inequality creates social ills but is also a key driver of wealth creation. Honest wealth creation benefits everyone, and income inequality is the engine of prosperity. The greater the income inequality, the higher the horsepower that the engine of prosperity will have.
POSTSCRIPT
None of this suggests that people work only for money or that money is the perfect motivator. On the contrary, the rewards of being productive come in many forms. Such rewards also add horsepower to the prosperity machine. Consequently, everyone should consider the effects of promoting or suppressing those other factors. That topic, however, must wait for another blog.
(I also recommend THIS SHORT VIDEO on income inequality.)
Further Reading:
- Insightful observations about the benefits of income inequality are delightfully presented in this article, “Surging Wealth Inequality Is A Happy Sign That Life Is Becoming Much More Convenient.”
[i] For example: “Income Inequality: Too Big to Ignore” by Robert H. Frank. This is full of misguided nostrums that I might explore in a future blog. Most of Frank’s errors are captured by this sentence: “There is no persuasive evidence that greater inequality bolsters economic growth or enhances anyone’s well-being.” There is plenty of persuasive evidence for those who do not have blinders to it. More importantly, however, immediately after making the second claim, Frank equates “well-being” with happiness. Frank falsely presumes that the goal of public policy is to make individuals happy. The goal of policy should be the improvement of the well-being of “everyone,” not “anyone.” For a different and more extended critique of Frank’s position, see or listen to THIS.
[ii] Society’s willingness to accept income inequality alone will not result in wealth creation. Rapid wealth creation cannot occur in the absence of certain preconditions, such as the rule of law, reasonable safety, property rights, sufficient mutual trust among trading partners, and virtuous citizens. (Deirdre McCloskey’s work in this area is extensive and very compelling. Also, see THIS JOHAN NORBERG VIDEO.)
[iii] Of course, there are many other motivations that cause people to create and produce. Despite that, the claim that people are motivated to work at higher levels in response to increased potential rewards is valid.
[iv] Of course, there are many other motivations that cause people to create and produce. Despite that, the claim that people are motivated to work at higher levels in response to increased potential rewards is valid.
[v] The reason that the pay for highly skilled people has risen relative to the pay for low- and middle-income workers is that investment money has been available to start highly promising companies. Every company needs highly skilled top executives, but not every company needs a large number of low-skilled workers. Technology can more readily substitute for the tasks low- and middle-income people perform than for the multiple, complex tasks top executives must perform. In other words, top executives only have to compete against other people, not robots, and there are relatively few people with the skills to perform those jobs well. As new companies are formed, the ratio of qualified top executives to top jobs has fallen, creating a continuing shortage of employees to fill them. Consequently, the value of top executive services keeps getting bid upward.
[vi] There is an upper limit, however, to how much can be paid for a particular job. Rarely (if ever) would it make economic sense for a company to pay an employee more than the value of the employee’s work to the company.
For an example of what happens to the motivation to create for people at the top end of their incomes, see Stevie Nicks’s comments on the lack of sufficient profit opportunities for successful people who have proven their creativity and abilities. See also Mick Fleetwood on the same subject.
Updated 03/16/26