Why redistribution is a lousy strategy to reduce poverty

Why redistribution is a lousy strategy to reduce poverty

By José Azel

Broadly speaking, our intellectual arsenal of political-economic strategies to alleviate poverty contains two conflicting ideas: income redistribution, and free-market economic growth. The first depends on the compulsive force of the government; the second of individual freedoms. As citizens, our task is to select the least flawed idea from this set of imperfect alternatives. Let’s look at it analytically in more detail.

In our society there are millions of people who have plenty of resources to meet their needs. They live with millions of others who do not have enough money even for their most basic needs. It is tempting to argue that we could maximize happiness, in economic terms, by redistributing resources from the rich to the poor.

The virtues of this idea of redistribution come from an economic concept fancifully called “decreasing marginal utility of wealth.” With it, economists point out that each additional dollar we earn brings us less happiness than the previous dollar. Because we allocate our resources to satisfy the most urgent needs first, the most highly valued.

For example, a poor homeless person would benefit greatly from $100 to buy food and basic necessities. But the same sum would not create much additional happiness for a millionaire. So, according to the redistribution argument, transferring wealth from someone abundantly rich to someone poor would increase the overall happiness of society, and this would be the moral behavior that governments should uphold.

However, the “decreasing marginal utility of wealth” principle on which the redistributive argument is based is not geographically limited. It’s universal. I mean, there are people all over the planet that are much poorer than even the poorest in the United States.

Then, the principle of “decreasing marginal utility of wealth” would lead us to prioritize policies that alleviate global poverty — not just domestic poverty — by redistributing resources from our poor to the poorest in the world. After all, the marginal utility of $100 for someone in impoverished Africa may be much higher than for someone in our poorest cities.

Furthermore, the income redistribution strategy has an even more pernicious flaw. Redistribution does not just transfer resources from one person to another; it also reduces the sum total of resources available in society at large. Again, this effect stems from the “decreasing marginal utility of wealth” principle.

Let’s see it this way: money can be used to consume or invest; namely produce. For the rich, since his basic consumption needs are already satisfied, producing is a more fruitful use of money than consuming. As income grows, the decrease in the marginal utility of consumption leads to allocate more resources to production: investing is more profitable than consuming.

But redistributive policies reduce the incentives to produce. If we are really concerned with social happiness, we must encourage production and growth. Policies that reduce investment in favor of short-term consumption slow down economic growth and increase poverty.

Free markets hide powerful mechanisms for reducing poverty, and we underestimate the power of economic growth as a strategy to reduce it. The economist and political philosopher Tyler Cowen reminds us that: “If a country grows at 5 percent per year, it takes 80 years to go from a per capita income of $500 to $25,000. Growing at 1 percent, the same increase requires 393 years.

Furthermore, one of the great virtues of the free market is that it promotes social happiness and poverty reduction without trying. As Adam Smith noted: “We do not expect our dinner from the benevolence of the butcher, the brewer, or the baker, but from their concern for their own interests.”

Markets are flawed, and we might consider them an inadequate poverty reduction strategy if there were feasible alternatives that would achieve better results. But there aren’t. Redistributing necessarily contributes to slowing down growth rates, and we should understand the damage that this by-product of income redistribution causes to the poor.

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José Azel left Cuba in 1961 as a 13 year-old political exile in what has been dubbed Operation Pedro Pan — the largest unaccompanied child refugee movement in the history of the Western Hemisphere. He is currently dedicated to the in-depth analyses of Cuba’s economic, social and political state, with a keen interest in post-Castro-Cuba strategies.

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