Causes of Wealth Inequality

Elizabeth Warren and Bernie Sanders continue to blast wealth inequality. But the twin leftists seem oblivious that wealth inequality may reflect starkly differing causes, as I discuss in a new Fox Business op-ed.

The Warren-Sanders broad-brush denunciations are useless as a guide to policy because high wealth inequality may reflect either the growth benefits of capitalism or the negative effects of cronyism and crowding out.

Capitalism here means economic freedom, entrepreneurship, and innovation. Cronyism means corruption and narrow benefits to particular groups. Crowding out means the displacement of private savings by the welfare state.

These causes of wealth inequality are loosely evident in cross-country comparisons. Countries such as Denmark, Sweden, and the United States have high wealth inequality combined with high levels of capitalism and large welfare states. Countries such as Egypt, Kazakhstan, Nigeria, and Ukraine have high wealth inequality likely caused by high corruption, as measured by this index.

The figure below shows a modestly positive correlation across 167 countries between the United Nations Human Development Index and wealth Gini coefficients. The HDI measures income levels, life expectancies, and education levels. Higher numbers are better. The Gini measures wealth inequality, with higher numbers meaning more inequality. Wealth Gini data (mine from Credit Suisse) are likely quite rough measures.

Generally, countries with more capitalism provide more opportunities for entrepreneurs to become wealthy, which in turn generates growth and raises overall human development. However, some countries with fairly high levels of capitalism—such as Japan—have low wealth inequality. Why wealth inequality levels in, say, Japan and Denmark are so different is a mystery.

So one takeaway from the figure is that the level of wealth inequality does not tell us whether a country is prosperous or not. Both Sweden and Nigeria have high wealth inequality, while both Japan and Ethiopia have low wealth inequality.

Warren and Sanders say they want less inequality, but that could mean they want America to be more like either Japan or Ethiopia. I’d like to hear more specifics from the candidates on the causes of wealth inequality. Which cronyist government programs do they favor repealing? Would their plans to expand social programs cause more wealth inequality?

Wealth inequality means nothing on its own. It’s the causes that count.

Research help from interns Dan Rothschild and Jay Zaleski.