Entrepreneurs, Capitalists, and Income Inequality

Originally published in Flourishing January 2012.

In 2009, there were 211,254,000 Americans over the age of fifteen who earned income.  If you earned more than $205,000 in 2009 you were in the top 1%.  If you earned $55,301 or more, you were in the top 20%.  Median household income in 2009 was $49,777. * 

So, for those of you in the top 1%, please know that I appreciate that you don’t have to be on Wall Street, much less the head of Goldman Sachs, to earn at that level.   I also know that none of you started in the top 1%, and I know that concerns about falling from the 1% can keep you awake at night.  Nobody wants to travel backwards in life. 

For the rest of us, it might be helpful to ask, who are the 1%?  The answer is that they come from all walks of life, but they generally fall into three broad categories.

Many of the top 1% of income earners in Americaare small business owners or entrepreneurs.  An entrepreneur can be defined as someone who acts to identify and fulfill the needs and desires of others in the marketplace in an attempt to earn money over and above the cost of acting; e.g., to earn a profit. 

Entrepreneurship—or running a business—involves every bit as much creativity as oil painting or novel writing. It requires imagination, understanding of the relevant tools and resources, and combining them into something new and different and valuable to others.  It’s hard work, even if—and especially because—it’s mostly mental work.  Very few people want to think as much, work as hard, take as much personal risk, or assume as much responsibility as is required of the successful entrepreneur and small business owner.

Others in the top 1% of income earners inAmericainclude highly skilled professionals, such as doctors, lawyers, executives, athletes, and entertainers.  Let’s give them their due; most of them work really hard, put in very long hours, and they have to study and train continuously to keep up with the demands of their professions.  For better or worse, most of us are lacking either the candlepower, or physical attributes, or work ethic that it usually takes to succeed in these challenging fields of endeavor.

That brings me to the capitalists, who make up a substantial portion of the 1% and much of the top 20%.  Most of today’s capitalists are people just like you and me.  In fact, they include you and me.  So, what do we do that makes us capitalists?

We do two things, and each is an incredibly valuable service to our fellow human beings; and each was an essential factor in the advance of our species from cave-dweller to homeowner, from fruit scavenger to grocery shopper.  The two things?

We defer consumption (we wait); and B) We assume risk.

Deferred consumption (waiting) was and is essential to human advancement for the simple reason that the production of food, clothing, and shelter takes time.  While we capitalists are waiting for the return of our money, entrepreneurs are using it to build and finance factories, houses, and automobiles; to create and market cell phones; to plant and harvest crops; and to do a million other things that take both time and money—a lot of time and a lot of money.  Because we wait for the return of our money (our capital), entrepreneurs and businesses can offer their hourly or salaried employees a regular paycheck.

We capitalists also bear the risk that the money we’ve saved and invested (rather than consumed) will be lost.  While the worker expects to be paid regularly, usually at least once a month, the capitalist may have to put his money at risk for years while awaiting a return on his investment. 

Sometimes, of course, two or more of the roles of entrepreneur, professional, capitalist, and employee are combined in one person.  And for each of those functions, it’s reasonable to expect compensation—sooner or later—depending on the terms and performance of each role. So now, let’s consider the fact of income inequality. 

First, although members of each of the three top earning groups I’ve just discussed are typically very smart, work really hard, and are very disciplined; that’s not the only reason they are in the top 20%, or even the top 1%.  We know this, because there are millions of smart, hardworking, and disciplined people, who are not in the top 20%.

The most basic reason that people make it into the top tiers of income earners is that there is a significant demand for who they are, or for what they do, or for what they’re selling—and they fulfill that demand more effectively or more completely than their competitors.  Each and every day, millions of Americans, and billions of people around the world, make purchasing decisions.  Those decisions ultimately determine what every product and service will cost, how many of each will be produced, and who will be rewarded.

If you’re a really good soldier, marine, or sailor; or teacher, or policeman, or fireman; or if you’re working in any of the thousands of worthy occupations from which we all choose, and you’re not in the top tiers of income earners, that may not seem fair.  But, of course, each of us makes our own “purchasing decision” when we decide what kind of work we want to do.   

We know going in what the potential of any job or career is or might be.  That potential is set by the demand for our occupation, how well we perform in it, and how many others are competing with us for a limited number of jobs, customers, clients, patients, investment opportunities, etc.

For example, investment bankers generally earn more than accountants, because, although accountants may be just as smart and hard-working, they are usually less tolerant of risk.  There are many more good accountants, therefore, than there are really good investment bankers.  A good chef will usually earn more than a short-order cook for very similar reasons.  In any field, skill and the willingness to tolerate risk and uncertainty are rarities, and they are usually accompanied by higher compensation. 

Which brings me to the concept of The Pyramid of Ability and The Law of Comparative Advantage

When it comes to playing basketball, I’m no Michael Jordan.  Heck, I’m no Jay Hrabik.  You may not know Jay, but he was the best player on our high school basketball team. (I was the 25th player on a team of 12.)  After serving in the U.S. Army for three years during theVietnamera, Jay became a CPA; but I’m getting ahead of myself.

After high school, and before Jay enlisted in the Army, he and I worked together at Bike’s Burger Bar.  Though Jay still disputes it, our skills as hamburger flippers were about equally developed.  I’m just guessing, but in hamburger flipping, Michael Jordan could probably have kept pace with either of us.  My point is that on the pyramid of ability, the three of us may have been equally talented hamburger flippers, and if we had all held that job at that time, we might have earned similar incomes. 

Again, I’m just guessing, but it’s very possible that Michael Jordan could have become either an investment advisor or an accountant.  On the pyramid of ability with regard to numbers, Jay, MJ, and I may have been similarly skilled, and we might have earned similar incomes, just as in flipping burgers. 

The good news for Jay and me is that fewer people can qualify to be accountants and investment advisors than can flip hamburgers.  That helps to explain why we gave up our jobs at Bike’s Burger Bar. 

But, Michael Jordan not only waived the opportunity to flip burgers, he passed on the chance to become either an accountant or an investment advisor.  That may not have been good news for the few people who would have become MJ’s clients, but it was great news for the millions of people who enjoyed watching “His Airness” play basketball. 

That’s The Law of Comparative Advantage, which probably also explains why Michael Jordan is making underwear commercials, and I’m not.   Neither, as far as I know, is Jay.

Do I resent the fact that Michael Jordan is in the top 0.01% of income earners?  Would I be better off if Michael Jordan earned less than he does?  Is Michael Jordan somehow taking something away from me? 

If Jay had grown up in another town, would that have made me a better basketball player?  If Michael Jordan had earned less money, would I have earned more?

The answers to all of these questions are obvious:  No!

Now, imagine that instead of becoming the greatest basketball player of all time, Michael Jordan had become a billionaire oil producer; or a billionaire investment banker; or a billionaire movie star. Are the answers any different? 

They are not.  Each of us is judged in the marketplace by our employers and our potential employers, our customers and our potential customers, our clients and our potential clients, our fans and potential fans.  Through their purchasing decisions, they tell us what our products and services are worth to them, and we can choose whether to provide them, or not. 

The incredibly wide range of products and services—and the equally wide  range of qualities and skills—offered in the marketplace, explains why there is such a wide range of income. 

Sometimes, we may feel we’re being judged unfairly or inaccurately.   But if that’s truly the case, it’s our responsibility to seek other markets or to develop new skills.  mh