Pareto Distribution

The past three posts [here, here, and here] were all a declaration that feminism doesn’t speak for me. That was prompted by a video of an interview with Jordan Peterson. I hadn’t been aware of him before, but I was certainly not the only one whose attention was caught by that interview. There were entire collections of responses to it on YouTube, and a series of memes featuring the flummoxed interviewer.

When you watch something on YouTube, a whole list of suggested videos appears based on what you were watching. I was thinking it was time for an economic post. It turns out Jordan Peterson can help there too. I came across one where he talks about income inequality, on the Joe Rogan podcast, from October 2017. (You can watch the whole 25-minute interview below.)

In this discussion, Jordan Peterson presents the problem, or the phenomenon of inequality. He refers to the Pareto distribution, which I had to look up. The Pareto principle is also called the 80/20 rule, which is, in essence, that 80% of outputs come from 20% of causes. And, further, 20% of producers bring about 80% of production in any particular class of production.

Image from Wikipedia, which explains
"The Pareto Principle claims that
only a 'vital few' peapods
produce the majority of peas."

Jordan Peterson explains it this way:

If you look at any creative endeavor that human beings engage in—so that would be an endeavor where there’s variability in individual production. It doesn’t matter what it is. Here’s what happens. People compete to produce whatever that is, and almost everybody produces zero. They lose completely. A small minority are a tiny bit successful. And a hyper-minority are insanely successful. And so, the Pareto distribution is the geometric graph representation of that phenomenon. And so, here’s how it manifests itself.

If you have 10,000 people, 100 of them have half the money. So the rule is, the square root of the number of people under consideration have half of whatever it is that’s under consideration. So, this works everywhere. So, if you took 100 classical composers, 10 of them produce half the music that’s played. And then, if you take the 10 composers, and you take 1000 of their songs, 30 of those songs, which is the square root of 1000, roughly speaking, are played 50% of the time.

So, when people work to produce something—anything: a product, wealth, music—the outcome will be unequal. Quite dramatically unequal. In a distribution we can estimate with a mathematical formula of

√X = ½ Y 

where X is the total number of something, and Y is the recipient of the reward or whatever you’re counting.

There’s a field of study that measures this kind of thing—econophysics. Econophysicists, Peterson tells us, “use the same mathematical equations that represent the propagation of molecules—gas molecules into a vacuum, to describe the manner in which money distributes itself in an economy.” Cool. I didn’t know that.

He also refers to the Matthew effect. This references the parable of the talents. To one man is given five talents (a sizable amount of money); he doubles that for the master and is rewarded. To another is given two talents, which he doubles for the master, and he is also rewarded. To a third man is given a single talent. He does nothing with it and returns only that single talent to the master at the day of reckoning. He made no use of what he was given, so he has that talent taken from him and no reward.

The verse referred to as the Matthew effect is 25:29:

For unto every one that hath shall be given, and he shall have abundance: but from him that hath not shall be taken away even that which he hath.

In a parable, things are metaphorical. It is about using what you have—not about producing five more or two more of something. But sociologists describe this effect as “the rich get richer and the poor get poorer.”

As we also know from scripture, “For ye have the poor with you always” (Mark 14:7), there will always be work you can do to help them.

The question being discussed in the podcast is a combination of “Why are the poor always with us?” and “Is there something that can or should be done about it?”

The whole discussion shows just how interrelated economic and social issues are. Given the Pareto effect, as long as people do different things, think up different things, and find solutions to various problems, they will acquire differing rewards for their efforts. Some will create wealth more successfully than others.

As Peterson explains, “The problem is, if you let a monetary system run, all the money ends up in the hands of a few—a very small number of people.” That is only a problem when things are wildly unequal—more than that, wildly unequal and with some having essentially zero—subsistence with no way out. Add to that a sense of oppression or systemic unfairness, and bad things happen.

People with no way out get desperate, which leads to high crime, or revolt. That’s what you see in Pearl Buck’s The Good Earth. I wrote about this result of disparity in 2015:

In Pearl Buck’s novel The Good Earth, there’s a point where the poor are starving and growing daily more desperate, squatting along the walls of the wealthy, until things get so heated, the poor rise up and raid the property of the wealthy, looting and killing. That was a book of fiction, but the Durants’ book [The Lessons of History] describes that as a typical cycle.

It might look like the problem is too much wealth at the top, but it’s really about too little at the bottom. When people are starving and suffering while the wealthy ignore their needs, that is an injustice that won’t stand indefinitely.

As Peterson put it, “If you don’t have any money, it’s really hard to get some. Once you have some, it’s not so hard to get some more.” And that's the underlying problem of inequality--not too much in some places, but too little in some places.

As Peterson points out, “what Marx observed was that capital tended to accumulate in the hands of fewer and fewer people, and he said that’s a flaw of the capitalist system. That’s wrong. It’s not a flaw of the capitalist system; it is a feature of every single system of production that we know of, no matter who set it up and how it operates.” 

But it becomes more troublesome when someone—usually a Marxist—reframes the situation as rich = evil and poor = good. It is not the fault of successful people that they tend to accumulate the good stuff. It is also true that being poor is not simply a matter of failing to work hard enough. Getting the ones at that near zero situation unstuck is necessary, not only for those stuck there to improve their lot, but also for the successful to not lose what they have from a revolt.

I don’t think the discussion got all the way to a solution, but Peterson frames it right:

You need innovation. You pay for innovation with inequality. But you need to bind inequality, because if it’s too intense, then things destabilize. OK, we can agree on that. We’ve got the parameters set. Now we have to start thinking very carefully through how to do the redistribution issue, and we don’t know how to do that.

I understand what he’s saying, but I wouldn’t use the term “bind inequality.” That sounds like something that needs to be imposed from some greater power—although I don’t think he intended that. He’s literally talking about the “redistribution issue,” but I wouldn’t use that term either, although technically that is the issue. Redistribution, again, sounds like something imposed.

What we really want—and he suggests, although I’m not sure how we get there—is “equality of opportunity. Because people are actually not as resentful about the success of others as you might expect; they’re resentful about it if they feel that the game is fixed.” He adds, “It has to be a straight game. And that’s why ethics is so important to keep this landscape stable. People can’t play crooked games.”

So a discussion of civilization has to come into it. People have to be honest in order for it to work for everybody.

Also, people have to care about those stuck at zero, where high IQ and conscientiousness—the best predictors of success—are just not enough to get going. In a civilized society, people care about one another. They give freely to help those who are temporarily downtrodden, or those who are not capable of helping themselves, or who just need a break.

We can only have that to give, if we’ve had enough success to build up surplus beyond our needs. And we only get surplus—or wealth—by creating more than subsistence and having a way to store the surplus. The most effective way ever invented—the natural way—is trade in a free market economy.

The answer comes down to free market—free of crony capitalism and con games—plus philanthropy. We’ve talked about that before [here, here, and here]. The addition today is, there will always be natural inequality, but even the wealthy benefit economically by being honest and giving freely. So, you need a civilized people to get and keep a healthy, prosperous economy.

Lesson from Economic Sphere

With Economic Sphere visiting this week, we’ve covered a few economic topics. And mostly I’m reassured that I’ve been on the right track.

Lesson 1: Thou Shalt Not Covet

One conversation the other day was about income redistribution. He asked me, of two job situations, which would I prefer? In the first one, I’m offered $50,000 a year, and my boss makes $55,000, 10% more. In the second I’m offered $100,000, and my boss makes $200,000, 100% more.

I answered sensibly: I’d prefer making $100,000. First, because I’m making twice as much money as I would have in the other job, and second, because the amount my boss makes shows a lot more growth potential for a career.

Surprisingly, when this question was asked in a study, an alarming number of people preferred making less money, as long as their boss made only a little more than they did. They thought it was immoral to have the boss make so much more than the employee.

We agreed that the morality is skewed. And the problem lies in that least of the Ten Commandments: Thou Shalt Not Covet. Why should it matter to me what a boss makes as long as I’m being fairly compensated for my work? The amount the boss makes is irrelevant. His job is different. He takes different risks, and has different expectations placed on him. His job probably includes some advanced education and experience in strategic planning.

The Ten Commandments, if they'd been written in English
image found here

I agree that some executives are overpaid. That’s a concern to the company, its board and stockholders, and to the extent that affects the company, also to the employees. But if the highest paid employee makes 20-fold what the entry-level employee makes, who cares, as long as he’s worth it to the company? Difference in income is simply irrelevant.

When you ask someone with that alternative moral belief, “What is immoral about someone making more than someone else?” and you get kind of a sputter answer. They think it’s self-evident; it’s unfair. But they can’t explain why different outcomes for different inputs equates to unfairness. They just have this internal sense that it does. What they don’t recognize is that refraining from jealousy over another’s fortune is a higher morality. Forcefully taking from a producer to give to a non-producer is simply theft, whether the state does it or a thug.

That’s why you see the argument for leveling the outcome for everyone in the southern hemisphere of the Spherical Model, where you also find tyranny and savagery. What you see in the northern hemisphere is actually more fair. And, because that is where you also find a more moral people, you also find them willingly giving aid to those truly in need—which means a two-way exchange of love as well. The giver gives to the poor because he loves and cares about him and wants to relieve his suffering. The receiver humbly receives, recognizing the gift was voluntary, and he is both grateful and determined to become productive and giving if he can. Love and gratitude are eliminated between people in the southern hemisphere, with the state placing itself in a godlike benefactor role, requiring gratitude and allegiance for its theft.

Lesson 2: No Central Planner Can Know Enough

This conversation was about the Superman comic strip nemesis Brainiac, which I was not familiar with. So I’m summarizing here without expertise. In the Superman, the Animated Series version, Brainiac was a “character” on the planet Krypton, where Superman was born. The people had developed a sort of central computer repository of knowledge, that became sentient—Brainiac. The idea was that everyone who learned anything would upload their information into this central brain, and then it would have all the knowledge necessary to make the wisest decisions for all.

This went well until a certain point in the history of the planet. Using only nonspecific technical jargon (which is what the series does), we learn that something has gone awry with the core of the planet, and it is going to blow up. This was the first time that Brainiac, the know-all computer, had a discrepancy between his purposes and those of the people he served. If he let the people know of the danger, they would expect him, even directly order him, to help them find a way to get everyone safely off the planet. He would thus be destroyed, but the people he served would survive. Or, he could use his processing power to upload himself onto something that he would get off planet—thus the people’s history and culture would survive, because he held it all within his brain, but the people themselves would die. He decided that was the better option; in order to accomplish it, he lied to the people, claiming the disturbance in the core was simply some seismic activity, nothing to worry about.

From Brainiac Attacks
image found here

Superman’s dad, Jor-El, as we know, knew about the danger to the planet. He tried spreading the word, but when people asked brainiac, Jor-El was contradicted. So he put his efforts into getting his son safely off planet before the explosion. So, there were two pods leaving Krypton in time, Superman’s and Brainiac’s.

The comparison here is that a central knowledge source is not simply a servant of the people who built it; it sees itself as its own entity of value—surpassing in value the individual people.

That led to further conversation about central planning, and how, no matter how all-knowing, no central planner can make decisions as consistently appropriate as individuals. The reason is that the central planner can never know the one most important thing necessary for making a decision about how I will spend my money: my preferences. I may not know them up until the time I find a pair of jeans in a store and try them on. I might prefer the feel of one pair over another. Or the way one pair fits my exact shape better than another—not measurement-wise, just in where things pull or tug. Or maybe there’s a subtle difference, like the topstitch color or the buttons that are the deciding factor for me. And I don’t know those things to feed the information into a central decision maker until I actually make the decision. How much worse is it if I am not allowed to make my decision, but must depend on the computer, using whatever amalgam of data it has up to this point, spits out as my decision?

The point is, no central planner, no matter how all knowing, has enough information to make better decisions for individuals than the independent individuals do. Friedrich Hayek’s The Road to Serfdom has this as a major theme. Economist Thomas Sowell explains it from time to time (here is one piece). 

Things that have been common sense to the common man (AKA: We the People) for centuries continue to be true.

The Rich Are Getting Poorer

The other evening my son Political Sphere was sharing with me Greg Mankiw's latest blog post. Mankiw is a professor of economics at Harvard; a textbook he authored is probably the most widely used for college freshman economics. He’s a free market guy, former advisor to Pres. Bush and advisor to Mitt Romney. And he has the skill of posting skillfully short blogs, with links to all the harder stuff.

Here’s the main paragraph:

 

According to the most recent IRS data, between 2007 and 2009, the 99th percentile income (AGI, not inflation-adjusted) fell from $410,096 to $343,927. The 99.9th percentile income fell from $2,155,365 to $1,432,890. During the same period, median income fell from $32,879 to $32,396.

 

Clearly the wealthy had a greater fall in income than the median (median means as many individuals earning more as earning less). But, then, the wealthy have so much more to lose, maybe they can afford it. So I asked what the percentage losses were. Political Sphere crunched the numbers and made me some charts.

 

This first one shows the simple amounts of loss for the different groups.

 

A median income earner loses the ability to make a car payment or two, or to buy a new computer, or to pay a dentist bill. It will be felt, but as long as this doesn’t continue year after year, it will probably be recoverable, and it looks like only the median earner and immediate family are affected. The overall economy might be more sluggish, but no jobs will be directly lost.

The top percentile earner loses enough to need to downsize by a couple of median employees, or sell a high end automobile. Or a mortgage payment would have to be $5500 lower per month, so a high end home would have to be sold, or would not be built at all. Even for one year, that amount has a significant impact on the top percentile, and on some lower earners as well.

 

As for the really high earner, the top 10^th of a percentile (best earner out of a thousand), the loss is almost three quarters of a million in income per year. That means that a business will not get startup capital, or an existing business will not expand. It means 22 employees that will get laid off and not rehired until the income returns with certainty. It means a high end home will not be built, or maybe three median homes that could have been rental property. The loss to the top earner is significant, and a sizable number of lower and median earners will be affected.

This second chart shows the percentage of loss to each of the groups.

 

So that means that for every $100 a median earner used to make, he/she has $99 to spend. Someone in the top percentile gets only $84 to spend out of every $100 he/she used to make. And the top 10^th percentile gets only $66 to spend out of every $100 he/she used to make. Mankiw’s point is that “high-income households have riskier-than-average incomes.” The more you make, the more you are likely to lose during economic downturns.

If you’re into class warfare, maybe seeing the rich get poorer makes you smile. But if you’re into a healthy economy, you’ll see that this isn’t about leveling the playing field; it’s about lowering the standard of living overall. More wealth created by those who know how to create wealth means more wealth in the economy as a whole, which affects everyone. Less wealth means less capital, less spending, less spreading it around. Maybe there’s wisdom in the commandment, “Thou shalt not covet.”