Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche


What is the Cause of Income Inequality?

Income inequality is the hot topic these days, and it is easy to see why. The Washington Post discovered that the average income in 81% of the counties in the United States is still less than it was in 1999. It even called its series on the topic The Middle Class is Lost.

The richest one percent of the U.S. population now controls 34% of the accumulated wealth. The wealthiest .1% of the U.S. population now controls around 15% of U.S. wealth.

One of the few economists to seriously research this topic, France’s Thomas Piketty, had an unlike bestseller with a rather boring tome called Capital in the 21st Century, which is available through Amazon. In his frightening book, Piketty accurately noted that income inequalities in developed countries like the United States, France, and Great Britain are now approaching levels not seen before World War I.

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So what is the cause of this situation? It certainly is not inherited wealth, as Mr. Piketty might like us to believe. Almost all of today’s fortunes were built in a single generation by entrepreneurs or financiers. Indeed, almost none of the historic names of America’s great fortunes, such as Rockefeller, Kennedy, or Vanderbilt, pops up on today’s Fortune 500 list.

An Intriguing shot of Thomas Piketty
An Intriguing shot of Thomas Piketty

Inheritance might play a role in future income inequality as Mr. Pinketty predicts, but not in the form of great fortunes. Interestingly, inheritance will probably have a greater influence on the middle and working class in the next few decades because many of them will be heavily dependent upon inherited wealth, such as parents’ houses or stock portfolios, to maintain their economic status. One reason for this is that the inheritance tax in the United States covers only the rich and not the middle class.

Nor is it any sort of capitalist conspiracy, as Neo-Marxists would have us believe. No secret cabal of evil plutocrats got together and created this situation. The evidence the Neo-Marxists give for their case, increased political lobbying by big corporations and declines in union membership, is hardly convincing.

The Real Roots of Income Inequality

The real roots of income inequality lie in technological and political developments over the past half century. These changes had as great an impact on history and everyday life as the Industrial Revolution or the French or American revolutions did, yet they are poorly understood and often ignored.

The biggest and, I believe, most important cause of the situation is technology. The productivity of U.S. workers has more than doubled since 1970. That means half as many people are needed to do the work. The cause of those productivity increases has been technological progress, including automation, robots, improved manufacturing processes, and higher efficiency.

The situation is made worse by the fact that today’s new technology is more likely to take the jobs of well-paid middle class professionals than working slobs, as MIT Sloan School of Management Professor Erik Brynjolfsson notes. In today’s world, a payroll clerk is likely to lose her job to software while a janitor is not, Brynjolfsson points out.


In other words, The Jetsons got it wrong. In the real 21st century, there is no Rosy the Robot, but there is a piece of software that Mr. Spacely can use to replace a clerk like George Jetson. Here’s a list of jobs threatened by technology that Professor Brynjolfsson prepared:

  • Secretaries
  • Stenographers
  • Payroll clerks
  • Bank tellers
  • File clerks
  • Cashiers
  • Typists
  • Pharmacists
  • Bookkeepers
  • Postal clerks
  • Butchers

To this list, we could safely add shipping clerks, insurance agents, stenographers, forklift drivers, photographers, typesetters, machinists, welders, carpenters, many construction workers, heavy equipment operators, miners, receptionists, paralegals, researchers, security guards, tollbooth operators, railroad engineers, ticket takers, meter readers, and warehouse workers.

The list also reveals one of the real causes of income inequality; the only labor position on Brynjolfsson’s list is butchers. Most of those jobs are professional and quite a few are office jobs. They were also the kind of positions that served as gateways to the middle class for upwardly mobile working class folk. The gateway to the middle class is now closed. My list is a little more conclusive, but it is also heavy on skilled labor jobs and lower middle class professions.

You see the problem here. Technology is most likely to take the jobs of those members of the working and lower middle classes that make the most. It also takes the jobs that provide them with some upward mobility. This also puts pressure on the poorest elements in society because people who would have historically advanced into better jobs do not.

The woman who would have been working as a secretary or a file clerk a generation ago is now running the cash register at Walmart. That means the maid or the waitress cannot advance to the cash register job. To make matters worse, the cashier’s job is threatened by, Apple Pay, PayPal, and Google Express. In a few years, the cashier is likely to be competing for the waitress or the maid’s job.

These jobs also concentrate wealth in the hands of those who own or control the technology. The average household income in Silicon Valley in 2013 was around $94,000, while the average household income nationwide was around $53,000.

Another problem is that technologies make it easier than ever for financiers and entrepreneurs to squeeze more money out of a business. When (NASDAQ: AMZN) started using Kiva robots at some of its fulfillment centers, warehouse costs dropped by 20%. The robots reduce the need for warehouse workers, another good working class job.

Seeking Alpha contributor Ark Investment estimated that Amazon’s “return on investment” in the robots should exceed 20% in the U.S. in four years. It also estimated that could cut operating costs worldwide by $800 million if it adopted robots at each of its fulfillment centers. That’s good news for Amazon stockholders, but bad news for high-school dropouts that need labor jobs.

Technology is the main cause of income inequality, but not the only one. Historical forces that no longer exist created a sort of forced equality in the 20th century.

World Wars I and II, and lesser conflicts such as the Chinese, Russian, and Spanish Civil Wars, helped create equality. World War I effectively shut down international trade, the main source of massive income growth in the late 19th century. This trade really did not recover until the 1970s.

The conflicts also diverted large amounts of resources that would have normally gone into wealth making to war making. This was done either through confiscatory taxes designed to finance the war or direct confiscation of assets for the “war effort.” At the same time, large amounts of wealth or property was either destroyed or stolen in the wars.

There were also fewer opportunities to accumulate wealth during the war. Many people that would have been entrepreneurs were in uniform. In the United States, the government put stringent restrictions on salaries in order to keep industry from competing with the military for manpower. Rationing deliberately stopped the production of consumer goods to force funds and resources into war production.

The result was a sort of forced egalitarianism; for an example of this, see the classic British movie Passport to Pimlico, a comedy about the desperate lengths that working class Londoners go to escape 1940s rationing. This forced egalitarianism ended quickly in the United States, but lasted longer in the Communist countries, where it was maintained by brute force.

There were also some attempts to maintain such equality in some European nations, notably Sweden and Britain. In the U.S., popular opposition to confiscatory taxes and other elements of the equality programs made this impossible. The failure of the Communist nations, and to a lesser extent that of the European welfare states, discredited this notion.

The lack of such historical forces, mostly all-out war, ideologically motivated forced equality, and technology, seem to be the real causes of income inequality. That also means income inequality is likely to stay and get worse. Technological progress isn’t likely to stop and is likely to accelerate. An all-out war is unlikely, and a modern war is likely to be fought by robots or highly paid mercenaries (the professional military), meaning it will have little economic impact.

It also means we’ll need new thinking, such as taxes on wealth and guaranteed income schemes, to deal with this situation because traditional solutions such as labor unions will not work. Interestingly enough, the work of economists such as Mr. Piketty indicates that labor unions may have little or no influence upon income distribution. I base this statement on the rapid decline of union political power.

Something that will definitely need to change is the U.S. tax system, which taxes labor and largely ignores wealth. That means potential government revenues are shrinking because the value of labor is shrinking. It also means that those making a shrinking percentage of the income pay the majority of taxes. We’ll need to go to a system that taxes the wealth.


Something else is clear. If we don’t deal with income inequality, social and political unrest will be unavoidable. One has to wonder how many of our cities will have to burn before we deal with this problem.