When I taught recently at the Summer School at Groningen University, I began my lecture on the measurement of inequality by distinguishing between the Italian and English schools as they were defined in 1921 by Corrado Gini:
“The methods of Italian writers…are not…comparable to his [Dalton of the English school] own, inasmuch as their purpose is to estimate, not the inequality of economic welfare, but the inequality of incomes and wealth, independently of all hypotheses as to the functional relations between these quantities and economic welfare or as to the additive character of the economic welfare of individuals”. (Corrado Gini, Measurement of Inequality of Incomes, Economic Journal, March 1921.)
I put myself squarely in the camp of the “Italians”. Measurement of income inequality is like measurement of any natural or social phenomenon. We measure inequality as we measure temperature or height of people. The English (or welfarist) school believes that the measure of income inequality is only a proxy for a measure of a more fundamental phenomenon: inequality in welfare. The ultimate variable, according to them, that we want to estimate is welfare (or even happiness) and how it is distributed. Income provides only an empirically feasible short-cut to it.
I would have been sympathetic to that approach if I knew how individual utility can be measured. There is, I believe, no way to compare utilities of different persons. We all agree that the marginal utility must be diminishing in income because it is the foundation of economic micro theory. (If marginal utility of income were not decreasing, we would not be able to explain why demand curves are downward sloping.) But we have no idea whether, while both your and my marginal utility functions are decreasing, my level of utility may, at any point, be orders of magnitude greater than yours or the reverse. Furthermore, and very importantly, “conditions of happiness are contradictory: happiness of a wolf is incompatible with the happiness of a lamb" (Pareto, Manual of Political Economy). So we cannot just add things up even if utilities were additive and we exactly knew how they look.
The only way for the “welfaristas” to solve this conundrum is to assume that all individuals have the same utility function, and to ignore the incompatibility. This is such an unrealistically bold assumption that I think nobody would really care to defend it. The escape into “social welfare” is just a way to claim that something exists which cannot be deduced from its natural units (that is, from individual utilities). The only reasonable escape was many years ago proposed by Pareto: distinguish between “utility of a community” (on which we cannot say almost anything) and “utility for a community” where politicians or dictators can decide what is good for society.
Now, the welfarst approach continues to be associated with pro-equality policies.
Why? Because if all people have the same utility function, then the optimal distribution of income is such that everybody has the same income. If from that equilibrium you take some income from A and give it to B, loss of utility of A will outweigh the utility gain of B (because marginal utility is decreasing) and thus obviously total utility will be less in any situation where income is not fully equally distributed.
My students then asked how I can justify concern with inequality if I reject the welfarist view which is the main ideological vehicle through which equality of outcomes is being justified. (A non-utilitarian, contractarian alternative is provided by Rawls. Yet another alternative, based on equal capabilities—a close cousin to equality of opportunity (of which more below) is provided by Amartya Sen.)
My answer was that I justify concern with income inequality on three grounds.
The first ground is instrumental: the effect on economic growth. After the period of the 1990s where, due to lack of data, we ended up with inconclusive results on the link between inequality and economic growth, we are acquiring more and more evidence that high levels of inequality slow down the increase in total income. We are able to show that now because we have access to micro data and a much more sophisticated view of both inequality and growth. Here, as examples, are the papers by Sarah Voitchovsky and by Roy van der Weide and myself. But, it has to be acknowledged: if empirical literature were to come to a different conclusion, namely that inequality helps growth we should have to drop that instrumental argument against high inequality.
The second is political effect. In societies where economic and political spheres are not separated by the Chinese wall (and all existing societies are such), inequality in economic power seeps and ultimately invades and conquers the political sphere. Instead of one-person one-vote democracy we get one-dollar one-vote plutocracy. This outcome appears inevitable, especially in modern societies where running political campaigns is extremely expensive. But it was not very different in ancient Greece or Rome. if we hold that democracy, a more or less equal influence of everyone on public affairs, is a good thing, we have to be in favor of severe limits on income and wealth inequality. It seems to me that the negative impact of inequality on democracy, not only obvious only in theory, is now being confirmed empirically as well (see Martin Gilens’ “Affluence and Influence”).
Let me note parenthetically that even if we failed to detect such explicit influence of the rich on policy making, the a priori case that it must exist (but is difficult to measure) would still be extremely strong. Because for the opposite case to hold, i.e., to argue that rich people give money to politicians but do not get anything in return, we have to assume an entirely irrational behavior of the rich: they throw money away for no reason. That goes so much against the fundamentals of economics that if we assume it here we should also assume it that when people go to restaurants; they throw money randomly: “Your glass of wine costs $10. Well, I will give you $15 and you do not need to give me the wine”. If that behavior seems reasonable to you, then I would agree that the rich may not influence politicians to whom they give money.
The third ground is philosophical. As Rawls has argued, every departure from equal distribution of resources has to be defended by an appeal to a higher principle. Because we are all equal individuals (whether as declared by the Universal Charter of Human Rights or by God), we should all have an approximately equal opportunity to develop our skills and to lead a “good (and pleasant) life”. Because inequality of income almost directly translates into inequality of opportunities, it also directly negates that fundamental equality of all humans. This is I think pretty evident on an a priori basis, but we have also an increasing number of papers that show the positive correlation between inequality of income and inequality of opportunity (see Marrero and Rodriguez, Miles Corak). Families with greater income ensure that their children have much better opportunities (which negates the fundamental equality of which we spoke) and in turn make sure they this new inequality of opportunity is converted into yet higher income for themselves and their own children. So, a positive feedback works very strongly to maintain unequal access to opportunities.
I have to say here that in addition inequality of opportunity affects negatively economic growth (so we now have a negative effect going from my third ground back to the first) which makes inequality of opportunity bad on two grounds: (1) it negates fundamental human equality, and (2) it lowers the pace of material improvements for society.
My argument, if I need to reiterate it, is: you can reject welfarism, hold that inter-personal comparison of utility is impossible, and still feel very strongly that economic outcomes should be made more equal—that inequality should be limited so that it does not affect opportunities, so that it does not slow growth and so that it does not undermine democracy. Isn’t that enough?
Might you want to qualify your views by taking into account physical disability? Which is a point that Sen frequently makes - the disabled might require greater income to reach the same level of wellbeing as the fully abled. And if we were prepared to address physical disability, what about social disadvantage due to gender, ethnicity, geography, history, etc?
So it's not "welfare" (per the English tradition), but "wellbeing" or "capabilities" (per Sen). I suppose the difference is that the English tradition assumes the same welfare function regardless of disability, disadvantage, history, geography etc. Whereas the latter doesn't.
Milanovic I'm awestruck by your empirical work but, apologies in advance, your normative political philosophy arguments are too often shallow, unconvincing and even worse, as in this case, self-contradictory.
"The third ground is philosophical ... Because we are all equal individuals ... we should all have an approximately equal opportunity to develop our skills and to lead a “good (and pleasant) life”. "
But that claim is inconsistent with you earlier rejection of welfarism:
"There is, I believe, no way to compare utilities of different persons. ... while both your and my marginal utility functions are decreasing, my level of utility may, at any point, be orders of magnitude greater than yours or the reverse ... Furthermore ... conditions of happiness are contradictory"
Because if we cannot compare the interpersonal levels of utility of persons A and B then we also cannot compare if A and B have been given equal opportunity to lead a "good (and pleasant) life" (a life of a certain level of welfare). Because, as posited by your rejection of welfarism, what set of opportunities A needs to lead a good/pleasant life can be "orders of magnitude greater" than what B needs. Or vice versa. In general if there is no way to know interpersonal levels of some final good X (flourishing, happiness, whatever) then there is also no way to know what amounts of some instrumental good (that when had hopefully down the line generates X) should be given to persons A and B respectively to be able to say that A and B now have "equal opportunity" to reach some level of X. Not even "approximately" - since we can be "orders of magnitude" off.
The bind you get yourself in is in a way reminiscent of the problems Sen points out with Rawls view being too "resourcist". But your bind is much deeper than Rawls' because you much more categorically reject welfarism and you make that "orders of magnitude greater" claim.
The only way out of the bind is to accept that interpersonal welfarism claims must be made in any view that makes interpersonal policy prescriptions. Denying that is the greatest and most harmful mistake ever in the field of economics.