Gini in the bottle: how inequality measures fail

The standard measures of inequality don't measure what they claim to measure. 

Because socialists lost the economic debate with the collapse of the Soviet Union, they have used other means to advance socialism, such as the environment or critical theory. Another prong of attack is inequality. Clearly, they say, socialism can't make us richer, but it can reduce inequality. They use measures such as the Gini Coefficient, which provides a single numerical score (0 to 1) representing overall inequality, and percentile ratios like the Palma Ratio (top 10% vs. bottom 40%) and decile ratios (e.g., 90th percentile vs. 10th percentile), which focus on specific parts of the distribution. Other measures include the Theil index and the Lorenz curve, which illustrates income distribution.

However, all fail because they use money to measure inequality. Mostly, they measure the expansion of fiat money. To see how they fail, we need to understand how money works in a true gold standard in which the money stock doesn't grow. Imagine a poker game in which five players each bring a thousand dollars to the table. Some will win hands and others lose. The winners take money from the losers. Because the total amount of money brought to the table is fixed at $5,000, the gains of one must equal the losses of the other. 

Capitalism is like a poker game only in the way that a fixed stock of money works. So if the money supply is fixed, how do living standards grow? They grow through productivity increases, or producers creating more using less labor. When producers produce more under a regime of a fixed money supply, good economists (mostly Austrian) grasp that prices will fall gradually at the rate of increase in productivity so that the existing stock of money can purchase all the available goods and services. 

For example, the Dutch Republic launched the great enrichment of the West by producing more food and clothing for the same amount of labor by using better methods and tools. More food, clothing, housing, transportation, furniture, etc., for less labor is the definition of wealth regardless of the money involved. The Dutch enjoyed a relatively fixed money supply under a gold standard, so the prices of clothing, food and carriages fell and became affordable to more people.  

In the Dutch Republic the incomes of consumers changed little, even though they are richer because they had more goods. Consumers bought more goods and services with the same amount of income. So, the common methods of measuring wealth through money incomes would fail to show an increase in wealth and inequality since incomes remained mostly the same.

What about the producers? If we oppose producers and consumers, consumers are spending or saving all of their money and so can't give producers more in a gold standard with a fixed stock of money. Where do producers using more productive methods get their money? From other producers who aren't as productive. More productive firms will offer lower prices and motivate consumers to buy from them, leaving some producers to go bankrupt if they can't adjust.

It's unlikely that consumers will spend all of their new wealth on more of the same products. At some point they will have enough food and clothing and will have money to save or spend on new inventions, such as books in the early days of capitalism. Books made several people rich as the ability to read spread.

Generally, in a system with a fixed stock of money, neither revenue to producers or income to consumers will change. If one producer earns more, it will be at the expense of other producers, not consumers. Inequality will exist because some people are more productive than others or create products, such as entertainment, that more people enjoy. That is natural inequality. But inequality will not grow in monetary terms because of the fixed money supply. 

Of course, that assumes a free market, the rule of law, equality before the law, low taxes, etc., or in other words, capitalism. Inequality can grow through higher taxation or theft in spite of the fixed stock of money because both make one group richer at the expense of others. Under capitalism, one can grow richer only by serving customers better and giving them a better value.

So what are measures of inequality that advertise an increase in inequality, such as Gini, measuring? Mostly, they measure growth in the money supply that benefits one group over another, or what is known as the Cantillon effects. Newly counterfeited money by central banks goes first to privileged organizations, financial institutions, who can spend the money on assets, such as real estate, the stock market or technology companies, before prices rise. That's why financial services and the technology companies they invest in have acquired much of the growth in incomes over the past generation. Workers get the new money last, after prices have risen, and are poorer. Taxes have similar effects by rewarding highly paid bureaucrats while impoverishing taxpayers.

The paper, “Monetary Inflation's Effect on Wealth Inequality: An Austrian Analysis” by Zoran Balac in the August 2008 Quarterly Journal of Austrian Economics provides some empirical evidence.

Ignorance of how money works, especially the differences between an economy with a fixed stock of money compared to one with massive counterfeiting of fiat money by central banks, means all inequality measures fail their objective. They measure the effects of a tsunami of fiat money, not increases or decreases in wealth. They would fail in a system with a fixed stock of gold money, but they fail more in a fiat system.

Socialists love to point out the slightly lower inequality in Europe because Europeans are so much poorer.