There are rich people, and a whole lot more poor people. ‘Twas 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 1800’s, 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
eccentric’s mattress – or possibly in an Arab Sheik’s money chest. Consider
that there is – 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 it’s accumulated by one person, it disappears
from another. (Sound familiar? Last I heard, we weren’t trading with the
Martians yet.) Bouchard and Mezard’s 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 you’re very skilled -- or
perhaps have a lot of child apprentices that you can get cheap labor out of –
you make more profit on your shoes than the neighboring shoemaker down the
street. Or maybe it’s 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 (let’s leave skill
out of it), you’ve 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 Hudson’s Bay Company. If you lose out, no
big deal: you’re down a few sous. If you hit it right, you make a
whole hell of a lot more sous – since the returns match the risk of
the investment. Or, if you’d 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. You’re 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 he’s suddenly having a tough time
making ends meet. For some unknown reason, the people walking down his
side of the street aren’t paying as much for his product. Expanding his
business or speculative investing are the last things on his list. He
can’t afford to take on any investment risk. If he has a fire in his shop, or
an unexpected financial burden, he’s 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, that’s what Bouchard and Mezard’s model seems to
demonstrate.
What makes this relevant to our modern world? All it does is reinforce the
"natural order of economic life": there’re 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 – there’s 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, it’s been estimated that in Mexico, the richest 40 people
own 30% of the entire wealth of the nation!
Bouchard and Mezard’s 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".
That’s 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?
Back to Essays...
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 – 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" doesn’t 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" that’s enjoyed by everyone: cheap energy
à technological innovation
à washing machines à
higher standard of living. It’s true that in the long run, that’s 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.
That’s why you should pay your engineers more!
