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The Rich and the Poor (Part II)

There are rich people, and a whole lot more poor people. ĎTwas ever thus.

The uneven distribution of wealth seems to be a pervasive, universal characteristic of society that spans all recorded time and all countries of the world. But why is this so?

In the late 1800ís, an Italian economist named Vilfredo Pareto discovered a pattern in the distribution of wealth that seemed to have a "universal" character. When dividing up the total population into equally spaced "bands" or segments of wealth, he verified the (obvious) declining gradient of population represented along the spectrum of wealth. More importantly, he found an interesting feature near the wealthy end of the scale: for each doubling of wealth, the number of people represented in each segment fell by a constant factor. This confirmed mathematically how much of the small fraction of the wealthiest people seemed to possess a lion's share of a country's riches.

More than a hundred years later, in 2000, a couple of French physicists (Jean-Phillip Bouchard and Marc Mezard) decided to study this "fact of economic life" by computational means. They established a network model using well-known equations of basic microeconomic processes to simulate the way wealth moves around in a society. Running their simulation in a time-based mode with a "starting condition" of equally distributed wealth, the "end condition" always showed a Pareto-like distribution. So there is some scientific basis to support the old saw that "even if everybody started out the same, a few people would end up with most of the money."

I am impossibly far from possessing even a modicum of economic astuteness. But if I understand the mathematical principles correctly, the "laws of economic chance" can easily explain these results. (I still remember the concept of the "money multiplier effect" from an introductory economics class I had to take, in about 1969. As I recall from my few waking moments between my many long naps in that class, every dollar in circulation gets spent at least 10 times before it "dies". Presumably, its graveyard is under some rich eccentricís mattress Ė or possibly in an Arab Sheikís money chest. Consider that there is Ė ideally -- a bit of profit taken in every "spending" of that dollar, and so some wealth moves around in those many "bread-and-butter" transactions. The other side of wealth comes from changes in asset values: property and investment shares.)

Of course, I suppose in any "closed" model, the movement of wealth is a zero-sum game; that is, when itís accumulated by one person, it disappears from another. (Sound familiar? Last I heard, we werenít trading with the Martians yet.) Bouchard and Mezardís model accommodates the interplay between these two wealth influencers: normal economic transactions and time-based changes in asset values.

Now consider the Utopian case where wealth is suddenly and equally redistributed among all the citizens. (I picture the French or Bolshevik Revolution here.) You are a shoemaker. Because youíre very skilled -- or perhaps have a lot of child apprentices that you can get cheap labor out of Ė you make more profit on your shoes than the neighboring shoemaker down the street. Or maybe itís just because the people that walk down your side of the street just happen to pay more for their shoes. So you have some extra sous to spend yourself. Through the vagaries of economic chance (letís leave skill out of it), youíve now got "more" than your competitor.

After you fill the bellies of your family, you decide to put a few sous into the hot speculative investment of the day -- say, buying up some tulip futures or picking up a share of the Hudsonís Bay Company. If you lose out, no big deal: youíre down a few sous. If you hit it right, you make a whole hell of a lot more sous Ė since the returns match the risk of the investment. Or, if youíd rather keep your risk close to your bosom, you put on some more apprentices, buy more shoemaking equipment, cut some bigger & better deals with the leather suppliers, and maybe expand or open another shop. Youíre well on your way to big-time wealth.

But how about the competing shoemaker down the street? He started off the same as you, but his profits are down and heís suddenly having a tough time making ends meet. For some unknown reason, the people walking down his side of the street arenít paying as much for his product. Expanding his business or speculative investing are the last things on his list. He canít afford to take on any investment risk. If he has a fire in his shop, or an unexpected financial burden, heís well on his way to economic ruin.

However it happens, a string of positive returns builds a person's wealth not merely by addition but by multiplication, as each subsequent gain grows ever bigger. This is enough, even in a world of equals where returns on investment are entirely random, to stir up huge disparities of wealth in the population. It has little to do with differences in the backgrounds and talents of individuals or countries. Rather, the disparity appears as a law of economic life that emerges naturally as an organizational feature of a network. At least, thatís what Bouchard and Mezardís model seems to demonstrate.

What makes this relevant to our modern world? All it does is reinforce the "natural order of economic life": thereíre always going to be lots of poor people, and a few rich people that control most of the wealth. But it comes down to a moral question of "rightness" here. The notion of "wealth control" falls along a wide continuum Ė thereís a big difference between the top 5% of people owning 40% of the wealth, versus them owning 95% of the wealth (as is closer the case now in the USA). There are even worse disparities out there. For example, itís been estimated that in Mexico, the richest 40 people own 30% of the entire wealth of the nation!

Bouchard and Mezardís model is interesting in that it illustrates how economic equality can be affected. The model shows that the greater the volume of wealth transactions flowing through the economy -- the greater the "vigor" of trading -- then the greater the equality. Conversely, the more volatile the investment returns, the greater the inequity. The model also confirms the assumption that income taxes will tend to erode differences in wealth, as long as those taxes are redistributed across the society in a more or less equal way. Similarly, a rise in capital gains taxes will tend to ameliorate disparities in wealth, both by discouraging speculation and by decreasing the returns from it. These last two findings go a long way in explaining why there has been such a dramatic rise in economic inequality in the US over the last decade. There is no question that the rich segments of the US population have been preferentially favored by recent changes in tax law.

The model also tells us more: That increasing sales taxes suppress economic transactions and results in a rise in inequality, and that tax policies geared toward benefiting the investment side of the economic equation ("trickle-down economics") also accelerate economic disparity between rich and poor.

Of course, for all of us, this brings to mind the recent dramatic slashes in capital gains tax rates -- and I even hear Neocon talk of a "national sales tax" on the agenda!

Bouchaud and Mezard also found that if the volatility of investment returns becomes sufficiently great, the differences in wealth it churns up can completely overwhelm the natural diffusion of wealth generated by ordinary economic transactions. In such a case, an economy - whether within one nation, or across the globe -- can undergo a transition wherein its wealth, instead of being held by a small minority, condenses into the pockets of a mere handful of super-rich "robber barons".

Thatís great news, just great. The saving grace is that, historically and eventually, these type of situations always seem to be "corrected". My only question is: Why do the corrections have to end up being so bloody?

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Extracted and paraphrased from The New Statesman by Mark Buchanan (2002)

See: Wealth Condensation in a Simple Model of Economy, Jean-Philippe Bouchaud (Science & Finance, Capital Fund Management) & Marc Mezard (Universite Paris Sud (Orsay)), 2000.

Image at top is Vilfredo Pareto, from http://www.marxists.org/glossary/people/p/pics/. Pareto started off as an engineer Ė I have to add him to my list of heroes!

Economic transactions may be a "zero-sum" affair, but the notion of "standard of living" doesnít necessarily follow from that. In principle, technology makes the tide rise, which floats all boats. Buckminster Fuller described this in terms of newer and better use of "energy slaves". For example, we can use the remains of dead dinosaurs to produce new "wealth" thatís enjoyed by everyone: cheap energy ŗ technological innovation ŗ washing machines ŗ higher standard of living.  Itís true that in the long run, thatís also a "zero-sum" situation -- but it does float our boats pretty darn high for awhile.

To better illustrate this, in the first US Census taken in 1810, there were a million families in America, and a million human slaves. By 1940, there were the equivalent of 200 "energy slaves" employed by every American family. Thatís why you should pay your engineers more!

 

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