Daniel O'Connor | Integral Ventures, LLC
Thanks to New Economist for pointing us to an article by Jenny Hogan of NewScientist, who reports on the new school of thought known as econophysics and its novel findings on wealth distribution.
In 1897, a Paris-born engineer named Vilfredo Pareto showed that the distribution of wealth in Europe followed a simple power-law pattern, which essentially meant that the extremely rich hogged most of a nation's wealth (New Scientist, 19 August 2000, p 22). Economists later realised that this law applied to just the very rich, and not necessarily to how wealth was distributed among the rest.
Now it seems that while the rich have Pareto's law to thank, the vast majority of people are governed by a completely different law. Physicist Victor Yakovenko of the University of Maryland in College Park and his colleagues analysed income data from the US Internal Revenue Service from 1983 to 2001. They found that while the income distribution among the super-wealthy - about 3 per cent of the population - does follow Pareto's law, incomes for the remaining 97 per cent fitted a different curve - one that also describes the spread of energies of atoms in a gas
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In the gas model, people exchange money in random interactions, much as atoms exchange energy when they collide. While economists' models traditionally regard humans as rational beings who always make intelligent decisions, econophysicists argue that in large systems the behaviour of each individual is influenced by so many factors that the net result is random, so it makes sense to treat people like atoms in a gas. The analogy also holds because money is like energy, in that it has to be conserved. "It's like a fluid that flows in interactions, it's not created or destroyed, only redistributed," says Yakovenko.
Yakovenko also found that the total income of those in the poorer part of the distribution did not change significantly with time after accounting for inflation. But incomes for those in the Pareto curve shot up nearly five times from 1983 to 2000, before declining with the US stock market crash of 2001.
This, along with research data from other countries, suggests that there are two economic classes. In one, the rich grow richer while in the other the poor stay poor. Yakovenko explains this by going back to the analogy of atoms in a gas. The atoms assume an exponential distribution of energy when they are in thermal equilibrium, and pushing the gas away from this state takes a lot of energy and it could prove similarly difficult to shift an economy to a different state. Randomness in the model does, however, mean that individuals can jump from one class to another.
Interesting stuff.
I makes me wonder how these research results stack up against other economic hypotheses and schools of thought, such as:
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General Equilibrium?
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Efficient Market Hypothesis?
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Rational Expectations?
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Behavioral Economics?
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Increasing Returns?
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Experimental Economics?
It also makes me wonder about the subjective implications of these objective observations:
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If our collective behavior appears to be random, does this imply that our subjective intentions are merely impulsive?
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Is it possible that no matter how carefully one might plan and strategize, one's results are rendered no better than random by the complexity and uncertainty of the economic system?
- Could it be that one must jump to that parallel universe of the Top 3% in order to experience what it's like to be intentional, strategic, and successful in our economy?
- What are the implications of these parallel economic universes for cognitive, affective, and moral development?
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How likely is it that the two distinct patterns of income distribution are themselves the result of some intentional design by those with the wealth and power to create the rules of the game?
Finally, I wonder what the curves would look like if:
- We used a different currency design that was not based on interest-bearing debt issued by a central bank, wherein one's proximity to the central bank money spigot and one's position on either side of the creditor/debtor equation can make a difference in one's economic performance. For example, what would the curves look like using data from before the US Dollar was completely removed from the gold standard in 1971? What would they look like if we simulated a market economy using a decentralized, free market, mutual currency created at the moment of exchange?
- We used a different tax code that did not place a disproportionate amount of the tax burden on those people whose incomes, coincidentally, fall within that range where the random curve begins a nosedive. To put it another way, is our tax code something of a glass ceiling obstructing a natural progression to the upper echelons of income and wealth due to the higher tax rates on income versus capital and the fact that social security taxes are levied on incomes up to $90,000, but not beyond?
- We had a pure market with clear and enforced "rules of the game" but no state interventions designed to alter the "outcome of the game." I would expect a pure market to generate income and wealth distributions far wider than a normal distribution, but I would not expect to see a bifurcation at the upper tail that gives this small minority the appearance of operating under a different set of rules. This seems like a research agenda for Experimental Economics.
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