As with my last post, I'm trying to catch up here in linking to my recent Bloomberg pieces. This is my last one from two weeks ago. Given all the recent discussion of rising inequality, I wanted to point to a really fascinating paper from about 15 years ago that almost no one (in economics, at least) seems to know about. The paper looks at a very general model of how wealth flows around in an economy, and points to the existence of a surprising phase transition or tipping point in how wealth ends up being distributed. It shows that, beyond a certain threshold (see text below), the usual effect of wealth concentration (a small fraction of people owning a significant fraction of all wealth) becomes much worse: wealth "condenses" into the hands of just a few individuals (or, in the model, they might also be firms), not merely into the hands of a small fraction of the population.
Are we approaching such a point? I've mentioned some evidence in the article that we might be. But the important thing, I believe, is that we have good reason to expect that such a threshold really does exist. We are likely getting closer to it, although we may still have a ways to go.
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We know that inequality is on the
rise around the world: The richest 1 percent command almost half
the planet’s household wealth, while the poorest half have less
than 1 percent. We know a lot less about why this is happening,
and where it might lead.
Some argue that technological advancement drives income
disproportionately to those with the right knowledge and skills.
Others point to the explosive growth in the financial sector.
Liberals worry that extreme inequality will tear society apart.
Conservatives argue that the wealth of the rich inspires others
to succeed.
What if we could shed all our political prejudices and take
a more scientific approach, setting up an experimental world
where we could test our thinking about what drives inequality?
Crazy as the idea might sound, it has actually been done. The
results are worth pondering.
Imagine a world like our own, only greatly simplified.
Everyone has equal talent and starts out with the same wealth.
Each person can gain or lose wealth by interacting and
exchanging goods and services with others, or by making
investments that earn uncertain returns over time.
More than a decade ago some scientists set up such a world,
in a computer, and used it to run simulations examining
fundamental aspects of wealth dynamics. They found several
surprising things.
First, inequality was unavoidable: A small fraction of
individuals (say 20 percent) always came to possess a large
fraction (say 80 percent) of the total wealth. This happened
because some individuals were luckier than others. By chance
alone, some peoples’ investments paid off many times in a row.
The more wealth they had, the more they could invest, making
bigger future gains even more likely.
For those who worry about the corrosive effects of wealth
inequality on social cohesion and democracy, the idea that it
follows almost inexorably from the most basic features of modern
economies might be unnerving. But there it is. A small fraction
owning most of everything is just as natural as having mountains
on a planet with plate tectonics.
Suppose we reach into this experimental world and, by
adjusting tax incentives or other means, boost the role of
financial investment relative to simple economic exchange. What
happens then? The distribution of wealth becomes more unequal:
The wealth share of the top 20 percent goes from, say, 80
percent to 90 percent.
If you keep boosting the role of finance and investment,
something surprising happens. Inequality doesn’t just keep
growing in a gradual and continuous way. Rather, the economy
crosses an abrupt tipping point. Suddenly, a few individuals end
up owning everything.
This would be a profoundly different world. It’s one thing
to have much of the wealth belonging to a small fraction of the
population -- 1 percent is still about 70 million people. It’s
entirely another if a small number of people -- say, five or
eight -- hold most of the wealth. With such a chasm between the
poor and rich, the idea that a person could go from one group to
the other in a lifetime, or even in a number of generations,
becomes absurd. The sheer numbers make the probability
vanishingly small.
Are we headed toward such a world? Well, data from
Bloomberg and the bank Credit Suisse suggest that the planet’s
138 richest people currently command more wealth than the
roughly 3.5 billion who make up the poorest half of the
population. Of course, nobody can say whether that means we’ve
reached a tipping point or are nearing one.
Experimental worlds are useful in that they exploit the
power of computation to examine the likely consequences of
complex interactions that would otherwise overwhelm our
analytical skills. We can get at least a little insight into
what might happen, what we ought to expect.
Our experimental world suggests that today’s vast wealth
inequality probably isn’t the result of any economic conspiracy,
or of vast differences in human skills. It’s more likely the
banal outcome of a fairly mechanical process -- one that, unless
we find some way to alter its course, could easily carry us into
a place where most of us would rather not be.
Mark, it`s great that you are coming back to this paper. You wrote a brilliant article about it, which is still online:
ReplyDeletehttp://www.newstatesman.com/node/143696
NS Essay - The science of inequality
02 September 2002
With it you changed the way I`m thinking of economics, society, history...
Your article is much more accessible than the paper, which is very mathematically. Free version:
Jean-Philippe Bouchaud, Marc Mezard. Wealth condensation in a simple model of economy. Science & Finance, Capital Fund Management; 2000. Available at: http://ideas.repec.org/p/sfi/sfiwpa/500026.html
Worth reading:
Bouchaud J-P. Economics needs a scientific revolution. Nature. 2008;455(7217):1181–1181. doi:10.1038/4551181a.
Bouchaud J-P. Economics need a scientific revolution. 08105306. 2008. Available at: http://arxiv.org/abs/0810.5306
Another more recent study arrives at the same conclusion:
ReplyDeletehttp://www1.umn.edu/news/news-releases/2011/UR_CONTENT_347891.html
If I recall, they recommend a rather high estate tax, which would prevent wealth from concentrating over longer time periods (for individuals, or families, at least.)
It's a very interesting idea, we tend to want to give more credit than is perhaps due to the 'winners' of our economy. Luck plays a huge factor, much larger than even the losers care to acknowledge.
Terrific article. Have I got this straight - the model operates globally, but in reality the rules of the game are set in each country?
ReplyDeleteI think this model probably best explains in-country dynamics. [global inequality is best explained by lack of economic development leaving some countries dirt poor] and trends in the US seem to mirror the tipping point theory.
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