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.

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A Letter to Wealthy (Inheritor)–Modesty in Abundance

I came across this letter from GD Birla to his son and this wealthiest industrialist has been an advisor to Gandhi and had great influence on his industry policy matters. Gandhi borrowed the concept of trusteeship to promote capitalism over socialism. Gandhi gave his blessings to the abundant wealth of Birla, to his teaching on trusteeship, a concept which asserted the right of the rich to accumulate and maintain wealth as long as the wealth was used to benefit society. This is the letter Birla wrote in Marwari language to his son, reproduced in English and is appropriate for every wealthy but still applicable to every individual to do whatever he can afford for good. This is a brief yet precise life principles concisely expressed with a fatherly affection and to be referred every time and anytime in a lifetime and perhaps continues to your future times (births) having read many times.

Dear Basant,
Whatever I’m writing, you should read even when you are grown up and also at your old age. I’m writing this from experience, as to how life must be lived.
Birth as human, is a rarity and when born as human, whoever misuses the birth, it is like he lived like an animal. You have wealth, health, good social connections. If you use them for the service of mankind, as a good human being, these are successful, else they are devil’s tools.
Never use wealth on selfish ends or merry spending, as wealth may not be there always. Spend less on self, more on public welfare and for the welfare of the distressed. Wealth is a force. Possibility of injustice is likely with this force or power. Take care that no injustice is done.
Leave some good morals for your children. If they indulge in merry-making, they become sinful and spoil our business. Do not pass on wealth to such unworthy children, rather use it for public welfare or distribute among deserving poor. Do not have mental blindness or passion for such children. Boundless effort and labor has been put in by we brothers, to build the business, assuming that our children will make best use of wealth we have generated.
Never forget God. He gives good sense and intellect. Have control on sensuous impulses, else those will sink you.
Do exercise and Yoga daily. Health is our biggest wealth. Health gives deftness, accomplishment and prosperity. I have seem how unhealthy millionaires become poor and frail. Eat meals feeling as medicine. Eat for living not live for eating.

G.D, Birla

After a long hiatus, back in action with Warren Buffet

It has been an ‘annus horibilis’ of sort, well yes and no. Yes as misfortunes and setbacks are part of life and no as you’ve the resilience, character and faith to overcome them. Hence, rather than seeing every year as either horribilis or fantastic, see it as part & parcel with equanimity. It is good to be back in writing action after a long procrastination. Live Writer has gone to ‘open source’  which is the right thing in this age of freedom expression – freedom of choice for best tool out there to pen your words and thoughts elegantly and post them efficiently. I’m starting off with legendary Warren Buffet’s wisdom from ‘My Warren Buffet Bible’ by Robert L. Blocch. Being a fan of buffet style investing where I disdain constant monitoring/trading to buy a worth and leave it grow. This book accentuates that idea clearly and provides investing plus life’s wisdom too. Some snippets from those wisdom:

  1. Wall street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway
  2. A great investment opportunity occurs when a marvelous business encounters a one time huge but solvable problem
  3. Should you find yourself in a chronically leaking boast, energy devoted to changing vessels is likely to be more productive than energy devoted tp patching leaks
  4. You have to do a very few things right in your life so long as you don’t do too many things wrong
  5. I’ll tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful
  6. Only buy something you’d be perfectly happy to hold if the market shit down for 10 years
  7. You should invest in a business that even a fool can run, because one day a fool will
  8. There seems to be some perverse human characteristic that likes to make east things difficult
  9. I tell everybody who works for our company to do only two things to be successful. They are 1) think like an owner, and 2) tell us bad news straight away. There is no reason to worry about good news
  10. Five years from now, 10 years from now, the world everywhere will be doing better
  11. When proper temperament joins with proper intellectual framework, then you get rational behavior – so true for investing and life too
  12. Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.
  13. Remember stock market is manic-depressive
  14. The difference between successful people and very successful people is that very successful people say no to almost everything.
  15. I insist on a lot of time being spent. almost everyday, to just sit and think. That’s very uncommon in American business. I read and think. So I do more reading and thinking, and make less impulse decisions than most people in business. I do it becuase I like this kind of life
  16. A pin lies in wait for every bubble. And when the two eventually meet, a new wave of investors learn some very old lessons

How to make a Million–Slowly

Practical wisdom from John Lee, is one of the UK’s leading private investor and MP to British parliament.

My Guiding Principles from a Lifetime of Successful Investing: These are the rules or principles that I’ve followed over the past 50 years of investing. These in gist provide some key lessons for the investor

  1. Endeavour to buy shares on modest valuations – hopefully with an attractive yield and single-figure price earnings ratio and/or discount to net asset value/real worth.
  2. Ignore the overall level of stock market. Don’t make judgments on the macro outlook – leave that to commentators and economists. Focus on your particular selection.
  3. Be prepared to hold for a minimum of five years.
  4. Have a broad understanding of the PLC’s main business activity – one which makes sense to you.
  5. Ignore minor share price movements. Looking back years hence you will have got it either right wrong; whether you originally paid, say 55 pence rather than 50 pence will be totally irrelevant.
  6. Seek established companies with a record of profitability and dividend payments – avoid start-ups and biotech or exploration stocks
  7. Look for moderately optimistic or better chairman’s/CEO’s most recent comment
  8. Focus on preferably conservative, cash rich companies or those wit low levels of debt
  9. Ensure the directors have meaningful shareholdings themselves in the PLC an ‘clean’ reputations
  10. Look for a stable Board – infrequent directorate changes. Similarly with professional advisers.
  11. Face up to poor decisions. Apply a 20% ‘stop-loss’ – sell and move on. However, ignore stop-loss if there is a major overall market fall.
  12. Let profitable holdings run. Don’t try to be too clever. i.e. selling and hoping the market will fall to ‘buy back’ at a lower price

Author’s note to encourage AGM attendance wherever possible – Which I reckon is great thing to keep note + the point 11 (advice) above.

Through attending these meetings, I have gained financially, had many amusing interludes, tucked into some excellent buffets and picked up at least one non-executive directorship. The psychology of AGMs is important to understand. The chairman is usually apprehensive, having spent hours with advisers preparing for difficult questions that might arise. Will the recently fired sales manager turn up to wreak his revenge?

Usually, of course nothing untoward happens and the meeting progresses without incident. The chairman relaxes, defenses down. This is the ideal time for a shareholder to move into action.

Take careful note of expressions, reactions, nuances – all valuable information. If the chairman is the dominant shareholder, any lack of family succession points to a future takeover. Sometimes you see clashes within families. Major institutions rarely attend AGMs (having their own private briefings) so the meetings are the private investors’ theater. But be strong wiled. Do not waste the time in which you could be gathering crucial information by going back for a second helping at the buffet. Circulate – and make sure you stay sober. Gaining entry into AGMs usually presents no difficulty – many companies are delighted just to have a shareholder turn up. Some have a table at the door on which sits an enormously inhibiting copy of the share register. However a look of authority, or saying rather grandly that your holding is in “nominee” names, usually suffices. The success, growth and integrity of the company (and thus you investment) is tied inextricably to the personality, abilities and ambitions of the chairman and/or the chief executives. If he owns a flashy BMW with personalized number plates, drips with gold jewelry and has ambitions to own the local football club – bad news. But a conservative car, gentleman’s shoes, love of cricket, faded regimental tie and membership of the local school board spell good news. I exclude from all this the 30-year old, multi-millionaire, whiz-kid creators of IT companies on price/earnings ratio of 50+. These live on a different planet, so normal judgments and personality tests do not apply.