Is inequality a function of individual ability, performance?

Is income inequality an inevitable result of full-blown meritocracy, allowing the ‘cream’ to capitalise on their talents and skills to raise their income levels, or are there other structural forces at play?

Lim Mah Hui points to political, social and market forces that have fostered growing inequality.

Lim Ewe Ghee’s article “Thinking about income inequality” in the Forum pages (Issue 922, 12 Aug) expounded on an important topic — income inequality, one of the mega trends of the 21st century. In fact, over the last four decades, the world economy has seen tremendous growth accompanied by increasing inequality in most countries.

I support the call for meritocracy as a means of rewarding people. But I do not agree with the conclusion that meritocracy justifies inequality based on the faulty assumption that unequal rewards are simply a function of individual ability (merit) and one that ignores structural factors and explanations that are more salient.

For a start, I concede that people are motivated by rewards, and that those who work smarter and harder should earn more than those who don’t. To pay everyone the same, irrespective of contribution, would be counter-productive. In other words, a certain degree of inequality, material and non-material, is necessary to motivate people to perform and for society to progress.

It is one thing to recognise this but another to jump to the conclusion that there is nothing wrong with extreme inequality or the suggestion that extreme inequality just indicates that things are working well — the rich get richer because they contribute more to society, are innovative, smarter and so on.

There are several flaws in this argument. The first is the assumption that inequality can be attributed to differences in individual traits and contributions. To quote Lim, “The infinitesimal diversity of personality traits, skills and talents in society implies that income inequality cannot but be the norm, not the exception!” (The emphasis is his.) Some inequality, yes, but if the diversity is infinitesimal, so should the inequality.

The article does not consider the fact that market, social and political forces, for example, can exert as much, if not more, influence on unequal remuneration. Say a smart and hardworking person becomes a teacher earning a modest salary. He then decides to switch jobs and become a stockbroker in a bull market. His income suddenly increases exponentially. Now, is this rise in pay due to his personality traits or skills or simply a function of market forces? He is the same person with the same level of intelligence.

Then, after several years of a bull market, the stock market collapses. He is out of a job and earns nothing. How does one explain this shift in income in terms of individual traits? It is clear that while inequality in income in an occupation may be explained by individual traits, the differences in income between occupations are due more to the structural forces in society. They also vary in different periods.

The above example illustrates another point of contention — people are rewarded highly because they contribute much to society. In Lim’s words, “Their high earnings are in fact a monotonic (sic) function of how well they have served humanity.” (The emphasis is his.) This is a variation of the functionalist theory of inequality that has been discredited in social science. This theory states that people are paid more because they do more important jobs and contribute more to society. How is importance and contribution to society defined? If it is defined by income earned, then the argument is circular.

Now, one can ask, are teachers, professors, artists, doctors, nurses and plumbers not doing important work and serving the people? Why are they not paid like bankers, stockbrokers and hedge fund managers? In fact, given the severity of the recent global financial crisis and the enormous pain financiers caused society, one should question their contribution to society and the disproportionate compensation they receive. How does one answer this?

A 2009 study by finance professors Philippon and Reshef (Wages and Human Capital in the US Financial Industry, 1900-2006. National Bureau of Economic Research, Working Paper No 14644), comparing compensation in the finance sector with that in the rest of the private sector over 100 years (1900 to 2006), showed that the former is consistently higher than the latter after controlling for skills, education and risks. They estimated that economic rent accounted for 30 percent to 50 percent of the wage differential.

Even taking Lim’s example of Bill Gates, one can concede that Gates produced something people wanted. But all of his economic success is not simply due to personal skills that society wishes to reward. Gates is also noted for his predatory and monopolistic practices of which his company was found guilty in both the US Federal Court and the EU Court; these are activities that undermine free market competition.

Many believe the market is always efficient and that the government should adopt a hands-off stance. Yet it is precisely government and regulatory agencies that play a role in preventing companies from becoming monopolists.

Another important question is, if some amount of inequality is inevitable, when does it become dysfunctional and unacceptable? It used to be that the average pay of CEOs was no more than 10 times that of an average employee; today in the US, it can be several hundred times. Is this differential due only to the productivity of one person?

Aren’t there systemic forces at play that inflate the remuneration of CEOs as in the way board members are appointed and the symbiotic relationship between the two? Are US CEOs so much more productive than their counterparts in Europe, Japan and South Korea?

There is also no relationship between inequality and economic growth. In the US, the periods after World War II and the 1970s saw the highest rates of economic growth, but also the lowest level of inequality and higher standards of living among the ordinary people. This was followed by a slowdown in growth despite deregulation, financial liberalisation and a spike in inequality.

Finally, there are many other serious social, political, economic and even financial consequences of inequality, the last of which are discussed in my recent book (with Lim Chin) on the relationship between inequality and the recent financial crisis (Nowhere to Hide: The Great Financial Crisis and Challenges for Asia, Iseas Singapore).

In its conclusion, Lim’s article asserts that one must have the right analysis to get the right policy mix. I agree with the writer on this, but I part by concluding that inequality is a highly complicated issue. It is misleading to reduce the explanation to simply individual merits, achievements and contribution to society.

Lim Mah Hui was a former international banker and university professor and is now a visiting Senior Fellow at Penang Institute. This story appeared in The Edge on 17 September 2012.