How Not to Fight Income Inequality

By Ricardo Hausmann

CAMBRIDGE ― Suppose two people hold different opinions about a policy issue. Is it possible to say that one is right and the other wrong, or do they just have different preferences? After all, what is the difference between an odd preference and a mistake?

A preference influences a choice that is expected to deliver the goal the chooser wants to achieve.

A mistake is a choice based on a wrong belief about how the world works, so that the outcome is not what the chooser expected. Unfortunately, this may be a costly way to learn.

It also may be inconclusive, because it is always possible to attribute the mistake's bad consequences to other factors.

A case in point is the decision by Mexican President-elect Andres Manuel Lopez Obrador (AMLO), to lower the salaries of the higher echelons of the civil service, including himself, capping them at $5,707 per month.

Many greeted the decision, announced in July, with glee. It showed that AMLO was committed to fiscal austerity and income equality.

But what appears to be a well-articulated preference will prove to be a serious mistake. Unfortunately, AMLO will find out only in a few years, by which point the damage inflicted on Mexico will be huge.

Interfering with market prices to achieve fairness ― an idea that harks back to St. Thomas Aquinas and even Aristotle ― is probably one of the worst economic policies ever Governments in many countries regularly set prices ― especially for energy, foreign exchange, or credit ― artificially low, leading predictably to under-investment and shortages.

Venezuela is an extreme case that dramatizes the consequences. But are public sector wages another example of this practice?

The answer is more nuanced.

In general, governments pay their employees significantly more on average than the private corporate sector, because government services such as education, health care, justice, and administration are on average more skill-intensive.

As a result, government employees have significantly higher levels of schooling ― four more years, on average, in Mexico.

But even controlling for this, a study by the CAF Development Bank showed that average wages are higher in the public sector in Latin America In Mexico, government employees' wages were about 13.5 percent higher than private-sector wages in 2012.

The same study also showed that wages in the public sector are significantly less unequal than in the private sector This means that while the public...