Stephen King: Remember the market knows best, Mr Brown

Those countries with the 'fairer' income distribution are also those with the poorer economic performance

"I SAY it is absolutely right to combine an agenda for encouraging and rewarding enterprise with an agenda for fairness." Gordon Brown's interview in last Thursday's Financial Times was clearly an attempt to underline the Government's commitment to business, irrespective of its social aims. The Chancellor went on to say: "We are looking to the productivity advances that were achieved in America after the mid-Nineties".

Enterprise, fairness, productivity. All these things are admirable aims in their own right. But are they truly compatible? America's success in enterprise and productivity has, in many ways, been truly breathtaking during the Nineties. Economic growth has consistently outpaced the best that has been on offer in other industrialised countries. Productivity performance has continued to impress, even during last year's downswing. And, despite the rise in unemployment over the past year or so, America's record in creating jobs has been a lot better than most others in recent years. Indeed, having run out of domestic workers, America has created jobs for others, either through immigration or through the export of US capital abroad.

It is a lot less apparent, however, that America fits the Chancellor's vision of a "fair" society. Fairness can mean all sorts of things and will be interpreted by different people in very different ways. Is it fair to tax people for their enterprise and hard work? If not, you end up with a right-wing view of only limited government intervention, presumably not quite the model that Mr Brown has in mind. Is it fair to leave people without the opportunity for a decent education and health service? Maybe not, in which case you may end up having to pay for public services through taxation, a view that seems to be at the heart of current thinking at the Treasury.

Old-fashioned measures of income distribution are not always the best way of assessing fairness. If you were hoping to achieve equality of opportunity, you might be indifferent to the eventual outcome, as long as you believed that everyone started off with a reasonable chance. Nevertheless, these old-fashioned measures do give some indication of the extent to which a society is delivering a balanced outcome. After all, a heavily skewed income distribution in one generation can become an even more heavily skewed distribution in the following generation through inheritance and the educational aspirations of the middle classes.

The data in this week's table confirm what most of us already knew. Unfortunately, the survey data used to come up with these numbers came from different years, so cross-country comparisons are not that easy to make. Nevertheless, a general pattern emerges. The poorest 20 per cent of the US and the UK populations have an unusually low grip on the overall resources of their respective nations. The other members of the G7 all do a lot better. There is less evidence of an underclass in continental Europe, Canada or Japan. At the other end of the spectrum, the top 20 per cent of the population in both the US and the UK have an unusually high grip on total resources. The shares accruing to the top 20 per cent of the population in the other countries are all considerably lower. If there is a "loadsamoney" culture, it is a culture that seems to be far more prevalent within Anglo-Saxon societies (maybe the French influence prevents this view from applying in Canada).

The problem with this table is that those countries with the "fairer" income distributions are also those with the poorer economic performance over the past 10 years, at least in terms of growth and productivity. Japan has the most equitable income distribution yet has been a truly awful economy. Of course, one could reasonably argue that Japan's problems – as with those in Germany and other countries – may have nothing whatsoever to do with income distribution. Instead, their difficulties may stem from overly bureaucratic states, overly regulated industries, excessive protection of worker rights, inappropriate levels of taxation etc, etc. Yet many of these constraints are there precisely to protect the incomes of those who might be considered to be the more vulnerable in society.

Ultimately, enterprise economies are driven by profits, which determine the allocation of resources. Not all profits are a good thing: a company that has established a monopoly in its industry may benefit its shareholders but is unlikely to help customers or suppliers (although Microsoft would probably dispute this). Generally, though, those industries where profits are abnormally high should attract new entrants while those with abnormally low profits should be shrinking. The expectation – perhaps ultimately false – that new technologies would lead to huge profits paved the way for the massive investment in IT and other related areas over the past few years.

The problem, however, is that profits are indifferent to winners and losers. An economy which encourages the free movement of capital and labour may lead to a superior overall allocation of resources but not much can be said about the distribution of the spoils. High profits will offer unusually high rewards and encourage risk-taking. Low profits – or, perhaps, losses – will lead to company closures and redundancies. These events are an inevitable consequence of a capitalist system.

The US gets round some of these problems by ensuring a relatively high degree of labour mobility across the nation. As a result, a large chunk of economic adjustment cost is placed on workers, who are forced to search for jobs up and down the country, uprooting their families in the process. In the UK and across Europe more generally, there has been less social acceptance of this approach and therefore a stronger incentive for governments to interfere with the operation of the "enterprise economy". This makes "fairness" and "enterprise" strange bedfellows. Fairness comes in when the costs of enterprise are deemed to be unacceptably high.

A truly enterprise-driven economy is one in which property rights are defended, where the market dominates and where people are free to buy and sell in any legal fashion. Monopolies, whether in the public or private sector, are an anathema to the free functioning of the market. The profit motive is vital because it ensures that resources are used in the most efficient manner. On the limited occasions when the market is unable to provide a solution – when, for example, there are social costs and benefits that cannot be appropriately priced – there may be a case for state intervention. Otherwise, the market knows best.

As long as transactions are engaged in voluntarily, why should the state or anyone else get involved? We may be unhappy about the randomness of the outcome. Yet stepping in to prevent an "unfair" distribution may then interfere with the smooth operation of the enterprise economy. Gordon Brown wants to be both Robert Nozick and John Rawls. Combining an agenda for enterprise with an agenda for fairness is all very well, but these are hollow words unless the trade-offs between these two, potentially conflicting, goals are spelt out clearly.

Stephen King is managing director of economics at HSBC.