Do read this fine piece by Tyler Cowen on different aspects of inequality. It’s stuffed with interesting ideas and thought-provoking arguments:

First, the inequality of personal well-being is sharply down over the past hundred years and perhaps over the past twenty years as well. Bill Gates is much, much richer than I am, yet it is not obvious that he is much happier if, indeed, he is happier at all. I have access to penicillin, air travel, good cheap food, the Internet and virtually all of the technical innovations that Gates does…

Compare these circumstances to those of 1911, a century ago. Even in the wealthier countries, the average person had little formal education, worked six days a week or more, often at hard physical labor, never took vacations, and could not access most of the world’s culture. The living standards of Carnegie and Rockefeller towered above those of typical Americans, not just in terms of money but also in terms of comfort.

Most people today may not articulate this truth to themselves in so many words, but they sense it keenly enough. So when average people read about or see income inequality, they don’t feel the moral outrage that radiates from the more passionate egalitarian quarters of society.

So far so ‘right-wing’?

But Tyler moves on to look hard at what has been happening at the very top end of earners and finds that within that rarified group a lot of people in the banking/finance sector have been making huge profits from ‘going short on volatility’:

In plain English, this means that some investors opt for a strategy of betting against big, unexpected moves in market prices. Most of the time investors will do well by this strategy, since big, unexpected moves are outliers by definition.

Traders will earn above-average returns in good times. In bad times they won’t suffer fully when catastrophic returns come in, as sooner or later is bound to happen, because the downside of these bets is partly socialized onto the Treasury, the Federal Reserve and, of course, the taxpayers and the unemployed.

It’s as if the major banks have tapped a hole in the social till and they are drinking from it with a straw. In any given year, this practice may seem tolerable—didn’t the bank earn the money fair and square by a series of fairly normal looking trades?

Yet over time this situation will corrode productivity, because what the banks do bears almost no resemblance to a process of getting capital into the hands of those who can make most efficient use of it. And it leads to periodic financial explosions.

That, in short, is the real problem of income inequality we face today. It’s what causes the inequality at the very top of the earning pyramid that has dangerous implications for the economy as a whole.

Hmm. What to do about this?

According to Tyler, no-one knows. For a good reason. It’s all necessarily too complicated to regulate:

There are more ways for banks to take risks than even knowledgeable regulators can possibly control; it just isn’t that easy to oversee a balance sheet with hundreds of billions of dollars on it, especially when short-term positions are wound down before quarterly inspections.

It’s also not clear how well regulators can identify risky assets. Some of the worst excesses of the financial crisis were grounded in mortgage-backed assets—a very traditional function of banks—not exotic derivatives trading strategies. Virtually any asset position can be used to bet long odds, one way or another.

It is naive to think that underpaid, undertrained regulators can keep up with financial traders, especially when the latter stand to earn billions by circumventing the intent of regulations while remaining within the letter of the law.

He identifies a scary but profound truth (emphasis added):

It’s no longer obvious that the system is stable at a macro level, and extreme income inequality at the top has been one result of that imbalance. Income inequality is a symptom, however, rather than a cause of the real problem.

The root cause of income inequality, viewed in the most general terms, is extreme human ingenuity, albeit of a perverse kind. That is why it is so hard to control…

Magnificent. Plenty more too, so read the whole thing.

As the Wikileaks and countless other examples show, we are en masse powerfully armed by way of information about the way things work, to a degree impossible to imagine for all of recorded human history until about 500 weeks ago.

This creates startling new network effects. Some are fun (Facebook, huge online chess-playing and other gaming communities) or important (massed PCs helping study the universe). Others are less fun (mad religious zealots, terrorists and other dangerous fanatics can network too).

But above all the soaring productivity of clever ways of doing things extends to the world of money too. In fact the world of money is at once an expression of those new network effects and a mighty force for driving them onwards.

All of which goes to reinforce my own view, namely that governments in principle can’t cope with this complexity and risk destabilising the whole world in their fevered efforts to do so.

The whole tone and message of government as it has evolved in the past 2000 years or so is ultimately paternalistic, controlling, limiting, restrictive. Government assumes that the public are too stupid to take their own risks and must be protected from themselves. Whatever the question, it is for government to define the answer. 

The popular frustration building up in the Western world at this state of affairs is mainly inchoate and inarticulate, maybe even incoherent. But at the heart is, I think, a feeling that we need to get back to self-control and a different, clearer vision of social discipline. That success should be rewarded, but also that bad behaviour must have bad consequences.

As Tyler Cowen shows us, that’s easy enough to say. But human cleverness makes it all too easy for some key people to grab the outcomes of success, and dump the costs of their own failure on to wider groups.