State’s moves to redistribute tends to destroy more wealth than is created

Martin van Staden / Midjourney
Martin van Staden / Midjourney

This article was first published by Business Day on 29 April 2024

It is generally accepted that wealth inequality is a bad thing. But the reality is more complex than a lot of simple questions assume. The answer really is: it depends.

Those who offer the simple answer would also be likely to say that government policies meant to eradicate inequality are a good thing. But again it depends on more factors than are immediately apparent.

Consider a small society — for argument’s sake, assume two households — that are entirely equal in wealth and income. Is that good or bad? Again, it depends. If both are on the edge of starvation with little to no wealth creation, equality of wealth is no virtue, it’s a death sentence. They live in perfect economic equality, but both could perish that way as well.

Now imagine that one of the households desperately begins planting more crops and working longer hours to produce more food to survive, and their level of wealth and wellbeing increases as a result. Is the increased wealth inequality a bad thing? I think most people would now agree that it isn’t.

Now consider a scenario where instead of planting more crops and working harder, one of the households arms itself and pillages their neighbour’s meagre holdings. Their level of wealth increases, and I think most rational people would say the increased inequality is a bad thing.

If both households plant and cultivate but one consistently out-produces the other, the former’s wealth will rise at a faster rate. This inevitably means they will go from perfect economic equality — albeit at starvation level — to one of increasing inequality. But the standard of living of both households will be improving, and both will be better off.

Does the increasing inequality of this scenario make the rising living standards bad? I think not. The bottom line is that income inequality can be good or bad, depending on how it came about.

Policies that favour those with political power harm those who are pillaged, taxed or regulated into increased poverty, while individuals who aren’t producing and are just politically connected, benefit. That encourages more of the poverty-inducing policies and discourages wealth creation, making the entire society poorer.

These examples drive home some important aspects of market liberalism. A prime observation of market economics is that social reality is far more complex than can be fully observed or accurately planned by authorities. All the trillions of information bits that would need to be accumulated for central planning to work are out of reach of any planner.

This diffused knowledge, if it could be accumulated, is already outdated by the time it’s observed, and supply and demand preferences have already changed. The information needed to centrally plan a complex economy with millions of actors simply isn’t something a planning body can accumulate. If by some miracle they manage, the information will already be outdated, rendering it useless for the goals of the planners.

Central planning is simply not possible, and political manipulation of markets is likely to produce bad results far more often than it manages, by fluke, to get things right. All you need do is compare state-owned enterprises such as SAA with the privately run airlines that use supply and demand as their tool of planning instead of what is politically expedient. The private airlines create more wealth than they consume, while SAA is like a giant toilet draining vast amounts of wealth.

The thing to realise is that voluntary economic trades tend to make all parties better off, albeit to varying degrees. But political measures to redistribute tend to destroy more wealth than is created, meaning a net loss for society as a whole. The virtue of markets is that information is accumulated in the form of price and profit signals. If profits are low it indicates supply is overly abundant and some resources should be directed elsewhere.

Self-interested entrepreneurs are out there always looking for just such opportunities. If profits are high they signal to vigilant entrepreneurs to produce more and reap the rewards. While the pattern of political manipulation of markets is pronounced in SA it is not exclusive to the country. It is found in nation after nation, and in each case it works out badly. The thing about reality is that it is almost always far more complex than simple solutions allow. The result is that simplistic solutions are usually wrong and typically do more harm than good.


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The views expressed in the article are the author’s and are not necessarily shared by the members of the Foundation. This article may be republished without prior consent but with acknowledgement to the author.




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