Pareto, Elites & Unequal Distribution

A fantastic book that repudiates classical and neo-classical models of economy which has led to countless busts and never was able to predict those busts and still clamors to be the best out there. These are the economyhths which are decimated in the book and a new order and model is what is required to counter the unknowns is enunciated but still this is not foolproof as we can never predict the next earthquake but lest be prepared. Some pages were fascinating and one such excerpt is the one below that I connect with is worth giving here to induce interest in this book Economyths by David Orrell. Happy reading!

It’s not that many young people do not have aspirations. It is that they are blocked Such elitism is unjust socially And it can no longer mark economically. Alan Blilburn MP (2009).

Economists are taught that, in principle at least, a well-run market economy is fundamentally fair, so while luck and random effects may be involved, our actual chance of success depends only on merit. The whole point of a competitive market, after all, is that everyone has an equal shot. This belief in an underlying equality influences everything from taxation policy to the pay packages of CEOs. Yet in recent decades, the income distribution has become increasingly skewed, with most of the benefits of increased productivity accruing to the top few per cent of the population. Ibe reason, as this chapter shows, is that markets are not fair and balanced, and the rich really do get richer.

Economic models in general have continued to shy away from distinguishing economic agents based on power, influence, access to information, connections, gender, race, class, or any other characteristic. As Norbert Häring and Niall Douglas note in their book Economists and the Powerful, such imbalances are ‘defined away by standard assumptions of most mainstream economic models’. Milton Friedman even argued that properly functioning free markets would automatically render them irrelevant: ‘there is an economic incentive in a free market to separate economic efficiency from other characteristics of an individual. A businessman or an entrepreneur who expresses preferences in his business activities that are not related to productive efficiency is at a disadvantage compared to other individuals who do not. Such an individual is in effect imposing higher costs upon himself than are other individuals who do not have such preferences. Hence, in a free market they will tend to drive him out.’ According to theory, sexism, racism or any other form of discrimination is inefficient, so in a pure (i.e. symmetrical) market it wouldn’t exist. Economic transactions are more or less the same, regardless of who is involved or when they take place. It is amusing to compare this picture with the highly ritualized, Vatican-like hiring practice standard in economics departments, which according to one sociological study is characterized by elitism, hierarchy, networking, and male-bias.) Of course, no economist would claim that the real economy is perfectly fair or stable, or that each participant has access to exactly the same information.

As seen with the subprime crisis, though, these assumptions soon begin to look ridiculous when you compare them with the real world. Markets aren’t just slightly asymmetric, they’re totally out of whack. Is it really OK to assume that Goldman Sachs and subprime mortgage holders are competing on a level playing field and have access to the same information? Is Wal-Mart versus the local corner store really a fair fight? And does it really make no difference where you are born, who your parents are, what schools you went to, who your friends are, or what your history is?

Circulation of the Elites
The French statesman Georges Clemenceau is attributed with the saying that ‘Any man who is not a socialist at age 20 has no heart. Any man who is still a socialist at age 40 has no head.’ Following a similar kind of trajectory, perhaps, neoclassical economics started off in an idealistic vein. aim of people like Jevons, Walras and Pareto was to put economics on a rational basis, and thus improve the living standards of the general population. Jevons was brought up in a Unitarian tradition concerned with social conditions, and spent much of his free time walking the streets of the cities he lived in — Sydney, Manchester, London — observing the conditions of the poor and contemplating the connections between poverty and economics. Walras inherited his socialist ideals from his father, and spent a number of years working in the cooperative movement before taking up his professorship at Lausanne.

As a young man, Vilfredo Pareto was a dedicated democrat, and took pleasure in- attacking the Italian government for corruption and corporatism. After the May 1898 riots in Milan, which were organized by the Italian Socialist Party and resulted in the deaths of hundreds of people, Pareto offered his home in Switzerland to socialist exiles and leftist radicals. Even by 1891, though, when Pareto was 43, it appeared that his head was pulling in another direction. He wrote to Walras. ‘I give up the combat in defense of liberal economic theories in Italy. My friends and I get nowhere and lose our time; this time is much more fruitfully devoted to scientific study.’  He began to believe that his youthful passion for leftist ideals had been based on emotion rather than logic, and that all human societies were inherently corrupt and irrational.
Pareto’s cynicism about human motivations was no doubt fuelled in 1901 when he returned home from a trip to find that his wife had run off with the cook and 30 cases of possessions. Under Italian law, Pareto couldn’t get a divorce. He had inherited a large sum of money from an uncle in 1898, enough to make him financially independent. In 1907 he resigned his university position and retired to his villa near Lake Geneva, where he lived with a woman 30 years his junior called Jeanne Régis, a large stock of the finest wines and liqueurs, and eighteen Angora cats (the house was called Villa Angora).

Pareto continued to blast off incendiary books, articles and letters, but his aim switched from trying to change society, to analyzing it from his detached vantage point — rather as an entomologist might analyze the social goings-on of an anthill, but with more spite and irony. In his million-word tome Treatise on General Sociology, he argued that human behavior is driven by irrational desires, which are then justified by particular ideologies. To understand society, one therefore had to focus on the underlying irrational desires, which he classified into six types. The most important were innovation (Class I) and conservation (Class Il). Everyone was motivated by a mix of these classes, but one could nevertheless speak of ‘Class I’ types, who are clever and calculating, and ‘Class Il’ types, who are slower, more bureaucratic, and dependent on force.

Pareto had earlier discovered the power-law distribution of wealth (the 80-20 rule) in Italy and other countries, and wrote that it ‘can be compared in some respects to Kepler’s law in astronomy; we still lack a theory that may make this law of distribution rational in the way in which the theory of universal gravitation has made Kepler’s law rational’. Today, we would describe it as an emergent property of the economy. In his retirement, Pareto came to see this highly-skewed power law as a kind of snapshot that revealed the underlying dynamics of any society.

At the top is a small elite consisting of a mix of Class I and Class Il people who are engaged in a Machiavellian struggle for power. There is always a degree of social mobility, so the composition of the elite changes as people enter or leave. The balance between the two classes therefore varies with time, in a process Pareto called the circulation of the elite. If too many innovative and intelligent Class I people (Machiavelli’s foxes) get in power, then the conservative Class IIS will plot a takeover. If the elite is dominated by Class IIS (Machiavelli’s lions), then it will become overly bureaucratic and reactive and the Class Is will make their move. This process can be smooth and gradual; but, if the circulation becomes blocked, so that ‘simultaneously the upper strata are full of decadent elements and the lower strata are full of elite elements’, then the social state ‘becomes highly unstable and a violent revolution is imminent’.
Pareto demonstrated his argument with numerous case studies. Perhaps the best illustration, though, was the coming to power in Italy of Mussolini’s Fascist government. Mussolini liked the idea of powerful lions taking over from foxes grown corrupt and ineffectual, and appointed Pareto Senator of the Kingdom of Italy. In 1923, Pareto finally managed to obtain a divorce and marry Jeanne Régis, before dying the same year.

How to get Rich
While Pareto’s sociological arguments have dated a bit in the last hundred years, his observation that wealth is distributed according to a power law has remained accurate — except that the elite has grown relatively smaller and more powerful. figure below is a summary of how the world’s wealth was distributed among the total 3.7 billion adults in the year 2000, according to a United Nations report. Adults required a relatively modest net worth of 2,138 to count themselves in the wealthiest 50 per cent To be in the top 10 per cent (370 million adults) they needed S61 This group owned over 80 per cent of the total wealth Anyone with $510,000 was in the top I per cent (that’s 37 million adults)- Together, this small sliver of the world population controlled 40 per of the world’s financial assets. Contrast that with the bottom half, who collectively controlled about 1 per cent of the wealth. Someone born into the world at random would stand a 50 per cent chance of ending up in that group of 1.85 billion adults. (As discussed in the update on page 216, wealth distribution in many countries has become considerably more skewed in recent years.)
Rather impressively, the power-law distribution of wealth extends all the way up to the world’s richest billionaires. In 2009 the world’s richest person was Bill Gates, with a net worth of $40 billion. To put that in perspective, suppose that you made a plot of the wealth of everyone on the planet, in order from richest to poorest. If you continued the plot up to the 99th percentile, then the vertical scale of the graph would have to be around half a million dollars (this will have changed slightly since 2000). But if you wanted to contain Bill Gates, or his friend Warren Buffett, then the vertical scale would need to expand by a factor of about 80,000.

image
Bar graph the wealth distribution in Yr 2000. The top decile (10 per cent) controls 80 percent of the total wealth. Deciles 6 through 10, which represent the bottom 50 percent of the population, control about 1 per cent in total

Wealth is also of course not distributed evenly in geographical terms. In 2000 the USA and Canada together had 34 per cent of the wealth, Europe had 30 per cent, rich Asian-Pacific countries had 24 per cent, and the rest of the world including Latin America and Africa held 12 per cent. This mix is changing as countries like China, India and Brazil continue to experience explosive growth and claim a larger share of the world’s economic pie. From these data alone, one can therefore conclude that the world economy is highly asymmetric. A small number of people enjoy a huge proportion of the world’s wealth, while billions live in poverty. same kind of pattern is seen repeating itself fractally over different scales. Every city has its own local elite, as does every country or region. Tie sprawling metropolis of greater Säo Paulo, Brazil, for example, now has some 500 helicopters, more than any other city in the world. The rich find them a good way to avoid traffic jams that can extend for over a hundred miles.ll Also they’re hard to steal.

Apart from his discovery of the power-law wealth distribution, another aspect of Pareto’s work to have passed the test of time was his insistence that humans act primarily on the basis of psychological, motivations, and justify those actions on the basis of ideology. Ellie ruling elite always has a very good argument as to why it should be in charge and have most of the wealth and be flying the helicopter. Today, that argument goes by names such as the invisible hand, the efficient market, or mainstream economics.

Broken Symmetry
Adam Smith’s concept of the invisible hand is usually taken to refer to the price mechanism. However, his first use of the expression, in his 1759 work The Theory of Moral Sentiments, is on the subject of wealth distribution: ‘The rich divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the necessaries of life which would have been made, had the earth been divided into equal pro- portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species.’ The invisible hand refers here not to the magic of the market, but to an early version of trickle-down economics.
Since the economy has patently failed to align itself with this happy picture, at the level of individual countries or the entire globe, one might ask what forces have created such a skewed distribution. According to Smith’s later work The Wealth of Nations (1776), free markets tend to drive prices towards ‘The natural price, or the price of free competition’. That applies to the price of labor, so it follows that an individual’s earnings should reflect the person’s inherent value to society. Efficient market theory similarly argues that markets allocate resources efficiently, and that includes wages. If Quetelet’s picture of the ‘average man’ is correct, and our abilities are randomly distributed according to a normal distribution, then one might expect wealth to be symmetrically distributed in the same way — most people would be in the middle, and there would be only a few who are very poor or very rich. The reality in most countries is obviously very different, so either our financial elites are incredibly talented, or something else is going on. One prevailing economyth is that the economy is inherently stable and at equilibrium i.e., it is symmetrical in time and so history doesn’t matter. However, there is the old saying that ‘the rich get richer’, and it certainly seems that to make a lot of money, it helps to have some in the first place.

Imagine as a thought experiment that a city-sized group of people are given a windfall of $100 each, under the condition that they must keep it invested in a rather volatile and unproductive stock market. Each person makes their own investments, with an average real return of 0 per cent and a standard deviation of 5 per cent. After one year, most people’s nest eggs will be in the range $90 to $110, and will be distributed according to the bell curve with a peak at 100 and a standard deviation of 5. As time goes on, though, the distribution becomes increasingly skewed. If we follow the worth of the investments as they are passed down through generations for 150 years (about the age of economics), then the resulting wealth distribution looks like a figure, which is quite similar to the actual wealth distribution in above figure. Obviously this is not a serious model of how wealth changes with time. It only tracks the value of imaginary investment port- folios, and ignores other kinds of economic transactions (more realistic agent-based models can be constructed, if desired). However, it does demonstrate the simple fact that, left to their own devices, investments will tend to concentrate themselves in fewer and fewer hands. To use the physics term, it is an example of symmetry breakings At the start of the simulation, everything is perfectly symmetrical. Each person has exactly the same initial amount of money. also have identical chances of success with their investments -— no one is assumed to be more talented at picking stocks, But over a period of time, some start to pull ahead of the pack reason is that there is a positive feedback effect at work A person whose sum has grown already from the initial $100 to $1,000 can hope to make another $I00 in the coming year. They might instead lose that much, but at least they have the opportunity, Someone whose savings fund has shrunk to SIO can only hope to make another dollar.
As the simulation is run for more years, the wealth becomes increasingly concentrated, until eventually only a few people are left gambling with the entire wealth of the community. If a person were born at random into such a population, their chance of being in the elite would be negligibly small. So even though the laws that govern this toy economy are symmetrical and non-discriminatory, the system tends to evolve towards an increasingly skewed state. Time matters.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s