By Graham Simon

Income inequality has come to the fore as the most pressing economic and social issue facing the world today. According to Credit Suisse’s Global Wealth Report 2013, 0.7% of the world’s inhabitants possess 41% of its wealth, 10% have 86%, and the poorest 50% hold a mere 1%.

A new book by French economist Thomas Picketty, Capital in the Twenty-First Century, has topped the bestseller lists. Picketty’s central thesis, supported by a wealth of historical data, is that over time the relative gains to owners of capital in peacetime economies are significantly higher than the returns to labor. His book proves beyond doubt what everyone has long known – the richer get richer while the poor get poorer, at least in relative terms. Pope Francis tweeted in April that “Inequality is the root of social evil.” Christine Lagarde, the head of the IMF, recently added her voice to the debate, warning that rising inequality threatens global financial stability, democracy and human rights.

While all may agree that inequality can tear nations apart, there is no consensus on the solution. Policy proposals to reverse inequality center upon taxation and redistributive measures. These are inevitably contentious. When owners of wealth, who came by their riches honestly, legitimately and, in their opinion, deservedly, are forcibly dispossessed through taxation or government fiat, resentment arises. If those same governments then expend the proceeds wastefully or corruptly, this resentment only deepens.

But there is another approach. It requires a basic understanding of economics and the application of some principled thinking.

Understanding Economics

The starting point of economics is scarcity. With scarcity comes the need to make choices. The economic cake is not infinite in size and there are a lot of hungry mouths to feed. The two perennial questions nations seek to address are how best to make the cake bigger and how to divide it up.

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