Inequality fallacies

There is a pervasive public prejudice that the rich always get richer and the poor are destined to become ever poorer. It should not be a surprise that this is a gross over-simplification.

This sense of a widening gap between rich and poor is deeply engrained. For instance, a survey on American attitudes published by the Pew Research Center, a non-partisan think tank based in Washington DC, found 76% agreeing with the statement “today it’s really true that the rich just get richer while the poor get poorer”.

There is an element of truth in this statement. Income inequality in the West has generally widened since the 1970s. However, even this trend is not as straightforward as it seems. Even the data series generally favoured by leftish commentators showed the real incomes of America’s top 1% falling in 2007-2009 along with stock prices.

In any case income is only one part of the story. Another, although often difficult to measure, is wealth. That is where the annual World Wealth Report, this year published by RBC Wealth Management and Capgemini comes in handy.

The 2012 report certainly helps give a more rounded view of the trends. It shows that in some respects inequality could be widening and in others narrowing.

For instance, wealth is becoming more broadly spread geographically. For the first time Asia-Pacific had the largest number of high net worth individuals (HNWIs – those with more than $1m of liquid assets) at 3.37m. Despite this rise North America remained the largest region for HNWI wealth in dollar terms with $11.4 trillion in assets.

There was also a narrowing gap between the merely rich and the super-rich both in terms of wealth and numbers. Although ordinary HNWIs rose by both measures the upper band of HNWIs, those with over $5m in assets, fell on both counts.

Of course none of this is to deny that there is a large financial gulf between the rich and the rest of us. But the idea that it is widening in a straightforward linear fashion in naïve.

In addition, it is important to counter the common logical fallacy that if the rich are getting richer then the poor, or even the mass of society, must be getting poorer.  It is quite possible for the rich to get richer and the poor to get richer at the same time.

Take a simple numerical example to illustrate the point. Suppose last year Richard earned £1m and Paul earned £10,000. Then this year Richard’s income went up to £2m while Paul’s jumped to £15,000. In this case the income gap between Richard and Paul has widened but Paul is still better off in absolute terms.

Indeed the long-term trend is clearly for the mass of society, including the poor, to become wealthier. Even today’s poor have wealth that would have been unimaginable to previous generations. Whether this trend will continue in the West if economic growth in the developed world fails to pick-up is another matter.

This blog post was first published on Fundweb today.