On inequality and consumption

A vibrant market economy benefits from more egalitarian income distribution

Inequality matters. Not just as an issue of fairness but also because a vibrant, market economy is much better off when wealth and income are spread around more evenly among the population. There are two reasons for this. First, consumption of certain goods and services “takes off” after a population reaches a certain level of income. Secondly, because the more people consume these goods and services, the more competition there is and the cheaper they become. In other words, the same amount of GDP among two populations but with vastly different distribution of income will result in vastly different consumption patterns; and consequently, production patterns as well. Let’s see how this manifests in real life.

A tale of two countries

When it comes to inequality, it’s hard to think of two regions in the world more disparate than Latin America and Scandinavia. Latin America has long held the title of most unequal region of the world, and even though most countries in the region are now considered “middle income”, a significant share of their population are still poor. Furthermore, those in the so-called middle class still have considerably lower purchasing power than a middle-class Westerner. In contrast, Scandinavia is one of the most egalitarian regions in the world thanks to a generous cradle-to-grave welfare state. When using Gini coefficients, a measure used by economists to measure inequality (with 0 being perfectly equal and 1 being perfectly unequal), Latin America tends to fall in the .45-.55 range. In contrast, Scandinavia usually ranks at .25-35.

I will be using Mexico as an example since it is the country I am most familiar with. According to data from the most recent household survey from 2016, the richest decile has a household income higher than the average GDP per capita of the European Union. It is fair to say that top 10% essentially lives like an average Western middle class would and most likely replicates their consumption patterns too. But as we move down from the chart, things quickly worsen. The second richest decile has an average household income similar to that of Latvia’s GDP per capita. Not bad, but a far cry from the rest of the EU. Meanwhile, the poorest decile has an average household income similar to Kenya’s GDP per capita.

If you were a business trying to sell middle-class goods and services, you’ll find out that the percentage of Mexicans willing to spend on these is much reduced, not just because of lower incomes but because of inequality. Due to diminishing marginal utility, most normal goods (those whose demand rises with income) follow a logarithmic pattern of consumption rather than a lineal one. Take, for example, meat. Meat consumption rises from near zero to 20 kg per head per year within the first $2,500 of income. It doubles to 40 kg before he first $5,000 is hit. But to double again to 80 kg, it takes more than $20,000 of income. You can expect the consumption of cappuccinos, yoga classes, art supplies, iPhones, and plasma screens to follow similar patterns, except with higher take off points.

What if Mexico was Norway?

But what if Mexico had Norway’s income distribution? To find out, I’ve extrapolated what Norway’s income distribution would look like if it had Mexico’s total income but distributed by Norway’s standards (latest data from 2017). The results are shocking to say the least. All but the two richest deciles would see an improvement in their household income, most dramatically among the poor: the poorest decile would be twice as rich. In contrast, the second richest decile would see a moderate decline income while the richest decile would be worse of by around 40%. If any of you wonder why there is such a reticence by elites to enact egalitarian economic polices, a look at this chart will tell you exactly why: they stand to lose out. By a lot.

And yet from a producer’s standpoint, even with the same total income, Norway’s distribution is much more favorable. Imagine a product whose consumption takes off at the midway point of Mexico’s income, around $6,800. Under Mexico’s distribution, only half the population would consume it. But under Mexico’s income but Norway’s distribution, it would be consumed by 80% of the population (only the two poorest deciles earn less than that). By and large, the consumption of most middle-class products will begin to take off at around $5,000-10,000 which means there will be more people to consume them under Norway’s distribution. In contrast, the products that take off after $20,000 are probably luxury goods. Many will be imported rather than produced domestically. Most will be profitable via high margins rather than high volume which means less people will be employed to produce them. The economy will benefit much less from these products than from normal goods.

It’s the competition, stupid

With more people consuming middle-class goods, there will also be more sellers and producers of those goods which also means more competition. And more competition means lower prices. If you’ve lived in a developing country, for example, you will have noticed that electronic goods like plasma TVs, smartphones, and computers are often pricier than in notionally more expensive Western countries (particularly Europe), even when considering higher VAT rates in the latter. For example, this article is currently being written on an Asus ZenBook laptop. Although the exact model is no longer on the market, a rough equivalent is the UX430UA which lists for £749.99 on Amazon UK. The exact same model is sold for MXN $20,999 on Amazon Mexico. Same store. Same item. But the UK version in pesos is just MXN $18,665, over a tenth cheaper despite the UK having a higher VAT rate than Mexico.

Tellingly, three were 9 third-party vendors offering it on the UK site compared to none in Mexico. On eBay UK, there were 32 sellers of this laptop compared to just 7 on Mexico’s Mercadolibre (the country’s main auction site). That’s a considerable difference in supply of the same product considering Mexico has almost twice the UK’s population. Given that Taiwan, where Asus is based, is more or less equally far away from both countries, one would expect the prices to be roughly equivalent. But no. Mexico’s poorer population also has to deal with paying more for the same thing than their richer British counterparts. Insofar as inequality results in less competition, everyone is worse off when buying the same things.

The contradictions of capitalism

Ultimately, one can’t understand the current popular discontent against liberal capitalism without making note of these contradictions. Although liberal capitalism sees no natural problem in the gross accumulation of income and wealth by a small segment of the population, the fact is that more egalitarian societies do better not just on measures of wellbeing but also on matters of consumption and competition, which are essential to capitalism’s success. And even advocates of democratic socialism (like myself) see no less need for a vibrant market economy running on the promise of competition providing better, cheaper goods and services for everyone. Especially the one who would otherwise be denied them.

Data sources: INEGI (Mexico), SSB (Norway)

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