February 19, 2014
By Oren M. Levin-Waldman, Ph.D.
Rising income inequality, of course, is problematic because it symbolizes the dual nature of our economy and the shrinking middle class. It is also dangerous to democracy because it tilts the power balance in policy formulation towards the interests of the wealthy away from the poor and the middle class. What is often not talked about is the relationship between rising income inequality, increased pressure for redistribution, and in the extreme revolution.
The more econometric models hold that as the gap between the rich and the poor expand the political situation is rife for violence and maybe even an overthrow of the existing political order, especially if it is believed that this order is in any way responsible for the growing disparity. This notion is by no means new. The very idea actually dates back to Aristotle’s Politics, whereby he states that two extremes in income distribution between the very wealthy and the very poor is extremely dangerous to the stability of the Polis — the political community. True enough, wealth and poverty are inevitable in any society, but a class division between a few rich and many poor can only lead to class conflict, and a constant threat of instability, violence and revolution.
On the contrary, the middle class has to be large enough to dominate the Polis so that neither extreme — the very rich nor the very poor — can take control. Contemporary thinkers, most notably the late Seymour Martin Lipset, restated this as democracy requires the maintenance of a middle class, and if necessary democratic governments would need to promote economic development in order to sustain it. Nevertheless, Aristotle’s observation perhaps reveals his distaste for redistribution as a remedy to the widening gap. But redistribution has often been the solution which has found expression in the median voter theorem, which to some extent is a formalization of Aristotle’s theory.
The median voter theorem holds that as income distributions are skewed to the right, the preferred amount of redistribution is a function of the relative position of the median voter on the income scale. The greater the distance between the median voter’s income and society’s average income, the greater is society’s preferred amount of redistribution. In other words, taking 2012 as an example, the median individual income in the U.S. was $31,000 a year, but the average individual income in the U.S. was $44,022, which was higher than the median income because high incomes at the top of the distribution effectively skewed the distribution to the right. The preferred amount of redistribution should be that which brings the median income in line with the average income.
The median voter theorem assumes that redistribution will take place through taxation And yet, we could render the median voter theorem obsolete simply by increasing the minimum wage, and indexing it either to the inflation rate or productivity gains. The minimum wage’s welfare effects, based on the macroeconomic model, potentially mitigate the need for redistribution because the distance between the median voter’s income and the average of society is effectively narrowed. This is because we can expect an increase in the minimum wage to result in increases in the median wages of those in intervals above the minimum. By narrowing the skew, the gap between the two extremes is narrowed, resulting in more of a middle class. And it will have been done with no redistribution in the form of taxation.
Although the employer has to pay the worker more, the benefits to society at large outweigh the costs to the employer in higher wages or even the consumer in higher prices. Workers have more money to spend and society saves on social costs. Workers earning more have less of a need for public assistance programs, and thus impose less of a social cost on the rest of society. Because workers earning around the minimum wage can also be expected to get pay raises, they will have increased purchasing power and be able to demand more goods and services, thus fueling job creation.
But employers also save too. They save on recruitment and retraining costs due to the high turnover associated with lower wages. Workers feeling better about their jobs tend to become more productive, thereby increasing efficiency. Rather than the minimum wage being about redistribution from employers to workers, it is about paying an efficiency wage. Moreover, given the lack of credible data that a minimum wage really will cause job loss, it only appears more reckless from a social stance not to increase the minimum wage.
Because we have been too preoccupied by the notion of the minimum wage as just another anti-poverty wage, or what some critics refer to as simply a feel-good measure, we often miss the fact that the minimum wage is really about the middle class. Nobody ever said that the minimum wage, in and of itself, was sufficient to rebuild the middle class, but it along with other measures can certainly help. The minimum wage can help to arrest movement towards the extremes Aristotle talked about and adherents of the median voter theorem have been concerned with.
It should be stated that the objective is not to make us all equal because that simply is not possible. We are all born with different endowments and we still are free to make our own choices. A market economy by its nature is not equal, and for that matter Aristotle was not suggesting that we needed to be. But a wage floor slows down the increase in wage inequality, which really should be the goal of policy. For income inequality to be reduced, the percentage increase of the average income of the bottom of the distribution has to be proportionally higher than the percentage increase of the average income of those at the top of the distribution.
Why is this important? Because if we want to preserve the basic fabric of a market economy, we must maintain social harmony. For market purists this no doubt is crossing the line, but it is also an example of Burkean conservatism whereby apparently radical steps need to be taken in order to conserve the traditions of the past. As much as paying workers more flies in the face of an economic orthodoxy of minimizing costs or the low-road strategy of low wages, it is still preferable to confiscatory taxation.