Why Is Wealth Inequality More Relevant Today?

Clive Smith

Russell Investments

The rise in wealth inequality across several major economies has been noted by many in the community. That this rising wealth inequality has potentially negative impacts on macroeconomic variables such as consumption, etc., is also broadly accepted. Yet there is the potential for rising wealth inequality to have deeper social and economic impacts due to other factors operating within the current economic system. In particular, there are reasons for believing that the meritocratically-driven market societies associated with many developed Western countries may magnify the negative impacts arising from rising wealth inequality.

Evolution of the market society

One of the defining features of modern economic systems is the evolution of market economies. What comprises a market economy is open to some debate, though at a high level the core characteristics of market economies are:

  • a key objective of profit maximisation;
  • a level of anonymity among buyers and sellers; and
  • a scope which covers most aspects of an economic system.

Market economies have become the cornerstone of most societies as they represent, at this point in time, the most efficient system for facilitating the pricing and allocation of scarce resources.

Though most accept the relative attraction of market economies, more open to debate are the social impacts associated with their evolution. Nowhere is this more apparent than in the logical extension of the market economy into broader social interactions and the evolution and development of the so-called ‘market society’. Market societies are marked by two key characteristics, namely:

1. the large-scale commodification of land, labour and capital; and

2. possessive, individualistic culture.

Unfortunately for those who view such characteristics of market societies negatively, it could be argued that the evolution of the market society is the natural, though not necessarily inevitable, extension of market economies.

Yet it can also be argued that these characteristics themselves are not necessarily negative and could in fact be viewed as existing to varying degrees even in non-market societies. It is only when these attributes become more extreme that a market society starts to exhibit more negative social implications, resulting in:

  • one putting one’s own wellbeing above the wellbeing of others; and
  • a fixation on private ownership, whereby people place a very high value on possessing private property.

When taken to more extreme levels, the by-product of these attributes is that a person’s sense of identity and self-worth is increasingly tied to how much he or she privately owns. Writers on this subject also refer to other characteristics, such as consumerism and faddishness, though in practice these can really be viewed as logical extensions of the possessive, individualistic culture associated with a market society.

Meritocracy

But what is the dynamic in a society that pushes it toward the more extreme, and potentially negative, attributes of a market society? Ironically, the propensity for a market society to be pushed toward such extremes is the potential for a society to simultaneously view itself as a meritocracy. At first blush, it may seem strange to view a meritocracy as a negative given that most people view the two core virtues of a meritocracy as being:

1. people’s economic income advantage turning on their accomplishments rather than their background; and

2. capacity and effort being much more widely and equally distributed than background.

It follows then that many view a meritocracy as being synonymous with equality. After all, who could possibly object to the inherent sense of fairness associated with having an equal chance of succeeding based on self-motivation, hard work and perseverance? Indeed, a focus on meritocracy could be viewed as going ‘hand in hand’ with a rising sense of individualism, which itself is at the heart of a market society, i.e. meritocracy puts a premium on individual ambition, hard work and perseverance as a vehicle of success. Therefore, a market society, coupled with a focus on meritocratic values, would appear to be the best of all worlds.

Unfortunately, the central issue is that a social focus on meritocracy hinges on the assumption that an objective criteria for merit and fairness exists. Academics highlight that a meritocracy ignores a range of external factors, such as disproportionately rewarding those who are more readily set up for success by having the structures and resources already in place to showcase their achievements. To simplify the discussion at a more fundamental level, the issue with a meritocracy is that it simply overlooks the fact that a large part of achieving a particular outcome may be impacted by a range of external factors which will simply be grouped together and collectively referred to as ‘luck’. It follows then that luck can not only intervene by furnishing the initial endowments of individuals but also by furnishing the circumstances in which abilities translate to success. Due to the intervention of luck, the result is that the link between ability and outcome is far more tenuous and indirect than a meritocracy allows for. Yet, for many, acknowledging the influence of external factors within a meritocracy downplays or denies the existence of individual ability.

It is this failure to recognise the influence of external factors which creates the ‘paradox of meritocracy’. The paradox of meritocracy occurs because a society which explicitly adopts meritocracy as a value potentially convinces its subjects of their own moral bona fides not only at an individual level but also at a national or aggregate level. Satisfied that the system is just, the subjects of a society risk becoming less inclined to examine their own behaviour for signs of prejudice. For many, the resulting attraction of meritocracy as a value is that it facilitates the belief that the world is just while explaining why people sit where they do within the social order.

Due to the paradox of meritocracy, the feedback loop associated with wealth accumulation transforms a meritocracy into the sincerest form of flattery. Where success is defined by the accumulation of physical possessions within a meritocracy, each material win can be viewed as a reflection of one’s own virtue and worth. A meritocracy can now become the most self-congratulatory of wealth distribution principles. It provides the potential justification for transforming the accumulation of physical property into praise and material inequality into personal superiority. By doing so, it provides scope for the ‘haves’ to view themselves as productive geniuses as opposed to recognising that they may simply be ‘luckier’. By the same token, worldly failures may unjustly become regarded as signs of personal defects, providing justification for why those at the bottom of the social hierarchy deserve to remain there. By doing so, a meritocracy not only encourages indifference amongst the ‘haves’ toward the ‘have nots’, but intrinsically undermines the ‘have nots’ by labelling them as unworthy due to their own personal failures.

Some may say that this sounds interesting from a theoretical perspective, but there is experimental support for adoption of meritocratic values having an adverse impact on individual behaviour. An interesting psychological experiment often run is the ‘ultimatum game’. In it, one player (the proposer) is given a sum of money and told to propose a division between himself and another player (the responder) who may accept the offer or reject it. If the responder rejects the offer, neither player gets anything. In many experiments where the amount shared is $100, most offers fall between $40 and $50. Often this result is viewed as supporting the proposition that people are inherently fair. But there is a more interesting variation of this experiment whereby the proposers are divided into two groups. Prior to making their proposal, those in Group 1 take part in a fake game of skill, which they are then led to believe they have ‘won’. The two groups of proposers then play the ultimatum game. Experiments fairly and consistently indicate that the proposals made by those from Group 1 are materially lower than the proposals made by those from Group 2.

The rise of wealth inequality in many economies is seen by most economists as a negative in terms of impacting longer-term economic outcomes. Yet there are also reasons to believe that the impact of rising wealth inequality within a meritocratically-driven market society may be materially greater, with deeper and longer-term social and economic implications. If this is the case, then the society itself may need to recognise and address not just wealth inequality but also the very values the market society has integrated within its fabric. Addressing such issues was put quite nicely by Thomas Wells when he referred to the potential need “to forge a new social compact for the twenty first century that will channel the benefits of commercial society to all in a fair way and to protect all of us, but especially the most vulnerable individuals, from its [capitalism’s] excesses and depredations.”



Clive Smith
Senior Portfolio Manager
Russell Investments

Clive Smith is the Senior Portfolio Manager on Russell Investments’ Australian fixed income team. Responsibilities span management of Russell Investments’ Australasian fixed income funds as well as conducting capital market and manager research...

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