Tuesday, December 13, 2011

The Top 1 Percent

Are the top 1% earning too much profit?  Much is being said about income inequality these days.  The rich are getting richer and the middle class is getting shafted, or something like this.  I have a few thoughts on this matter, but probably raise more questions than I provide answers.

In a market-based economy, consumers and producers enter into exchange freely.  We aren’t coerced by the government or anyone else to part with our money.  Obamacare may change this, but that’s another post.  We are also free to choose among different merchants when we choose to enter into exchange.  I can shop at Wal Mart, Target, or Sears – it’s my choice.  Each choice comes with tradeoffs, but I make them according to my own personal judgments.  Only I can decide what’s best for me.  So, I’m free to exchange when I want and with whom I want.

Because I’m free to exchange when and with whom I want, producers must compete for my business.  A firm that offers a product of a sufficient value to appeal to the masses will likely earn more profits than a firm whose product is less appealing.  Because I’m free to exchange and businesses must compete for my business, those earning profits are rewarded.  Profits are a signal that the firm’s products are highly valued by consumers.  This is a good thing, because firms will continue to make these products adequately abundant at prices consumers demand.  Occasionally, some producers are rewarded handsomely and become rich.  I would define rich as a measure of not income, but assets.  Think balance sheet and not income statement.

Now, the rich producers have earned enough income that they rank in the highest percentile of all the income brackets.  The fact they have earned income means the market places an extremely high value on their products.  If John Billionaire were producing products that folks didn’t like, it’s highly unlikely John would be in the top 1% of income earners.  To interfere with this arrangement via taxes or regulations would not only harm John, it would harm the many consumers who benefit from John’s products.  Taxing John would likely reduce his output and cause prices to rise.  Who besides government benefits from this?  Unnecessary regulation would have the same effect.  So, is the fact that John’s level of income ranks him in the highest percentile bad?  I don’t think so – provided John isn’t a rent-seeking crony capitalist who enlists the legislature to help peddle his products.

If John is earning economic profit, this is a signal for more entrepreneurs to enter the market.  More entrepreneurs producing the same or similar good will cause prices of those goods to fall, along with economic profits.  This is also a good thing.  Consumers will have even more choices and enjoy lower prices.

In a totally free society, many folks from the non-rich group would see the economic profits being earned by the rich and desire to earn profits themselves.  They would bring their products and services to market in hopes of earning profits.  The cycle then repeats itself, and the market allocates profits to the best producers and consumers benefit.  Any arrangement where the market isn’t allowed to be the allocator of capital and labor is bad.  I think Milton Freidman once said that people spending their own money will do so with much more caution than when they spend someone else’s money.  People may waste money, but no one can waste money like government.

Now, if government regulation makes it too hard to bring your product to market, folks from the non-rich group will have a much more difficult time navigating the marketplace.  They may be unable to afford lawyers, permits, licenses, surety bonds, and the like.  Rich producers can afford those things, and may even petition the legislature to enact more laws erecting even more barriers to entry.  This happens all the time and is bad for consumers and the non-rich group.  Reducing taxes and relaxing regulations, something this current government has no intention of doing, would help clear the way for more non-rich to enter the market and begin earning profits.

So, if there is a problem with the rich getting richer at the expense of the non-rich, I assign most of the blame to cronies and government regulators.  What are your thoughts on the matter?

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