Since the financial crisis, economists such as Joseph Stiglitz of Columbia, Raghuram Rajan of the University of Chicago, and even staffers at the International Monetary Fund have begun to argue that income inequality causes economic damage. Not only does extreme inequality such as now seen in the U.S. threaten social comity, they argue, but also, by tending to fuel crises and other busts, it undermines a nation’s capacity to sustain growth.

This new focus on inequality merits a cheer — but not three. Economists close to the mainstream have not dared to challenge a crucial yet unrealistic theory about income — inserted into first-year texts, carried through graduate courses, and employed in journal articles — that points just the opposite way. It says that markets determine wages, and any social or political tampering just creates inefficiency.

In his best-selling textbook Economics, even the progressive economist Paul Samuelson announced as an undisputable verity that social efforts to equalize income such as minimum-wage laws or union bargaining just kill jobs, while “a labor market characterized by perfectly flexible wages cannot underproduce or have involuntary unemployment.” In the 1990s, a whole subfield of economics reached “virtually unanimous agreement,” as a survey in the Journal of Economic Perspectives noted, that in the context of technological change, markets themselves inevitably drove U.S. income inequality.

As a result, we have come to rely on progressive taxes and social programs to soften income inequality. Opponents have taken aim at these policies, too, arguing that inequality is entirely market-determined, and even fighting it in roundabout ways causes inefficiencies. But President Barack Obama and other politicians who wish to soften inequality should take heart. Markets do not determine income inequality. It is fundamentally a social decision.

Indeed, Adam Smith maintained just this view, writing in 1776 that each society settles on a sort of living wage, allowing workers to buy goods that “the custom of the country renders it indecent for creditable people . . . to be without.” His successor David Ricardo concurred that income distribution depends on the “habits and customs of the people.” As the Industrial Revolution marched on, labor leaders began to proclaim a more threatening twist: class conflict determines income distribution. Karl Marx was actually a latecomer to this view.

Around the turn of the 20th century, economists began to try to justify income inequality. “The indictment that hangs over society is that of ‘exploiting labor,'” John Bates Clark, a founder of the American Economic Association, noted in 1899. Clark set out to disprove this indictment. The market rewards each of us according to our actual productive value, he insisted: “To each agent a distinguishable share in production, and to each a corresponding reward — such is the natural law of distribution.” This supposed “natural law” slowly conquered the mainstream during the 20th century.

And by what mechanism was this natural law enforced? The reasoning goes something like this: Economists posit as an assumption that firms always have a wide variety of techniques to choose from. They can build cars by using, say, 50 fewer assembly workers and 100 more robots, or vice versa. If the robots are a little cheaper, install them and fire the workers. More broadly, whether making cars or doing accounting, firms shop for the best buy among “factors of production” — using more capital and less labor, or vice versa, depending on costs — just like smart shoppers looking for the best buy among products at the supermarket.

If firms can, indeed, make such substitutions and thus shop for factors of production as if they were consumer products, then markets do determine the value of each worker and each piece of capital. If firing 50 workers and installing 100 robots shaves just a little off production costs, then each of those workers is worth slightly less than two robots. And that’s what firms pay.

Does production really work this way? It is so contrary to workaday experience that beginning economics students find it tough to grasp. Look at the raw muscle and crude machinery, so vividly depicted by Diego Rivera in the Detroit Institute of Art, that powered Ford’s River Rouge plant in the 1920s. Could managers, like smart shoppers at the market, have chosen to employ more automated machinery instead of workers? Of course not. They had no idea how to.

Today, the textbook economist might counter, robots can be substituted for workers. But that doesn’t really solve the problem. For example, in 2006, when Ford opened a plant in Chongqing, China, where wages were a fraction of the German level, a spokesman said it was “practically identical to one of its most advanced factories” in Germany. Ford managers could not use more cheap Chinese labor and less automated machinery because they had no idea how to. How could numerous workers replace computer-controlled tools and still achieve the precise tolerances required of modern automotive technology?

Of course, technology changes over time, but at a given state of the art, managers cannot tell what the future may offer. For example, in the 1980s, General Motors wasted $40 billion trying to implement the science-fiction fantasy of replacing recalcitrant workers with robots. Having utterly failed, GM undertook a medium-tech, $200 million joint venture with Toyota to implement “lean-production” methods relying more heavily on workers’ skills — and boosted productivity 40%.

Since in the real world managers rarely have any sure idea how to use more capital and less labor, or vice versa, markets cannot determine how much workers earn. An old union joke (or anyway, union organizer’s joke) underlines this point. Question: “What’s the value of an assembly-line worker?” Answer: “It’s the steering wheel.” Everyone from the executive suite to the shop floor contributes as a team to production. Markets may determine what cars sell for but cannot tell how much of that value each team member contributes. Somehow, minimum wages, personnel departments, union bargaining — social custom, in other words — decide earnings.

As long as economists stick to their assumption about production, it will imply that markets determine wages, and do so most efficiently. Progressive economists will recognize that income inequality can harm economies — in their efforts to overcome it, clueless Americans borrowed extravagantly against supposed home values and helped cause the financial crisis. But given their fanciful assumption, these economists will continue to balk at direct and practical remedies for inequality such as negotiating more equitable wage structures. This assumption will continue to tie economic thinking in knots.