Income gap is inefficient

 / 14 Feb '13, 5:19pm

Of all South Africa’s economic indicators, income inequality is the most dangerous. It has the potential to unravel society at the seams and crumble the foundations on which the wealth that exists has been built.

The World Economic Forum’s Global Risk Report has rated inequality as one of the top global risks for 2013.

Filomena Scalise

South Africa constantly ranks among the most unequal nations of the world. The richest 10 percent of the population earn just over 51 percent of the country’s total income. That means the other 90 percent of the population share only 49 percent of what is earned in South Africa. The poorest 20 percent receive less than 1.5 percent.

These numbers include social grants but exclude earnings on capital gains, which, if included, would increase the gap.

Inequality does not necessarily infer poverty because it refers not to the levels of income in a country but to the differences in income between the richest and poorest.

Over the past century the world has made incredible gains in fighting poverty and, by World Bank measures, the percentage of people living in extreme poverty has halved over the past 20 years.

But while the number of poor has decreased, the gap between rich and poor has never been so large. It is true that meeting basic human needs remains the most important goal in development, but doing this while allowing the income disparity to explode has severe consequences.

First, inequality is economically inefficient. Regardless of how much the superrich are able to buy, there is a limit to how much of their wealth they can practically use. A centralisation of wealth from the majority to a select few results in a decrease of overall demand.

It slows the circulation of money and spending, and ultimately decreases the number of jobs being created.

Take for example Shauwn and S’bu Mpisane’s 25 luxury vehicles, which were recently taken from them due to fraud charges. Assuming these were for personal use, at any point 23 of these were lying dormant. It would be more efficient if, to an extent, wealth was distributed and these assets were being used in a way that generated income for third parties.

Simply having money does not create jobs. Jobs are created when this money is reinvested into goods or businesses that then create wealth for others. Wealth is better circulated and more efficiently used in an economy when it is not centralised under the control of a few individuals.

Second, inequality leads to political instability. When a country is characterised by an extremely rich minority and a poor majority, the richer elite inevitably has greater control over the leadership and is able to steer it to meet its own interests.

Throughout history there are examples of how leadership is violently overthrown when inequality reaches a tipping point. This is a trend of unequal societies, not poor ones.

The recent farm strikes in the Western Cape are a case in point. The area of unrest boasts some of the highest farm wages in the country, but it is also the area of the highest income disparity.

Solving inequality is not about making the rich poorer. It is about preserving a system whereby a sufficient income gap exists to allow an incentive for innovation, hard work, risk taking and wealth creation, but where the pursuit of wealth is inclusive of all those involved in building it.

Pierre Heistein is the convener of UCT’s Applied Economics for Smart Decision-Making course. @PierreHeistein