As a follow-up to my discussion on the Pareto Distribution and the distribution of wealth in society, I note a recent article in Bloomberg Businessweek magazine from October 25, 2010. ( http://www.businessweek.com/magazine/content/10_44/b4201008238184.htm ) This article "The Inequality Delusion" by Drake Bennet discusses an upcoming study by two psychologists [Dan Ariely from Duke and Michael Norton from Harvard Business School] on how wealth in the US is actually distributed and how starkly this distribution differs from most peoples' expectation. For example, when people in a large survey were asked what percentage of the nation's wealth was controlled by the richest 20%, the average response was 59%. When asked what they believed would be an ideal percentage, the average response was that the richest 20% of the people should control just 32% of the nation's wealth. The "actual" percentage of the nation's wealth controlled by the richest 20% is...... 84%! Shocking! Well, maybe not too shocking since this is essentially what Pareto found in his initial studies of the same phenomenon through history. It is essentially the 80/20 rule as described by the Pareto Distribution.
I'll admit I was a little surprised by this article. First, do people on average really believe that the richest 20% of the people should control just 32% of the nation's wealth? Wow! Second, while my guess on the survey question would have been 80% because that is roughly what Pareto found, I am still surprised at how close it was to that number. As big a fan as I am about this whole concept, I feel there has got to be a tremendous data problem - specifically: "how do you measure wealth?" I would think that the variability of wealth measurement methods and quality of data would significantly shift the results from study to study. Also, socialist or communist societies have a whole different conception of wealth and ownership. My feeling is that in a communist society the same 80/20 rule may still hold, but only if you change the concept of wealth ownership to "ability to control resources" such as through political power. My understanding is that Pareto himself was socialist/communist earlier in his life but became disillusioned when he saw the politically powerful in these economic systems displaying the same wealth/power grabbing behavior as their non-socialist counterparts.
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I enjoy reading your blog. Your ideas definitely make me think!
ReplyDeleteIn the 2010 December 15 New York Times (page A23), Ray D. Madoff, a professor at Boston College Law School, wrote that in 1916 the richest 1 percent of Americans controlled 50 percent of the wealth of the country. He went on to assert that through the estate tax and other progressive policies over the next 60 years the percentage of wealth controlled by the richest 1 percent of Americans was reduced to only 20 percent. He then noted that in the last 35 years the tax policies have reversed that trend with the richest 1 percent now owning more than 33% of the wealth of the country and is trending up.
My point being that the distribution of wealth in this case is not static, but changes with the tax policy and laws of the land. The percentage of wealth controlled by the richest 1 percent , the richest 20 percent, or whatever other percentage of Americans you want to use, changes over time. And at times the difference in wealth will be the Pareto Distribution of 80/20. But the distribution will also sometimes be 70/30.
So, if the percentage of wealth owned by the richest x percent of Americans can be influenced through government policies, the question is, “How much wealth of the country should be owned by the richest 1 or 2 or 20 percent of Americans? What percent should a democratic government with a capitalism-based economy aim for?” America as an economic entity did quite well when the wealth of the richest 1 percent of Americans trended down from 50 percent to 20 percent.
I suspect the American public would say the country is on the right track when more and more Americans are getting a bigger slice of the pie. And most people would say the country is not on the right track when fewer and fewer people are getting a bigger slice of the pie. There is probably a study about this somewhere...
I wonder too how Pareto's 80/20 rule can be static in the face of so many different policies and economic structures. I find that one of the fascinating puzzles here - though I suspect there was academic wizardry going on. My biggest issue is how to measure wealth. That has got to be pretty subjective.
ReplyDeleteI note that the 1%/50% figure you quote is very consistent with a 80/20 Pareto distribution. Of the 80%, 80% of that is controlled by 20% of the 20%. Do that one more time and you get a number very very close to 1% control 50%.
The 80/20 rule really just reflects one set of parameters for the distribution - and the 80/20 rule we quote today that is attributed to Pareto is simply an interpretation of his work. And the Pareto distribution is just one type of power law. Its not so much the exact parameters of the distribution that interests me. It is the shape of the distributions - the fact that they can be so different form the traditional normal distribution- and their tendency to reflect situations that can shift from being very boring to extreme volatility.