American Dream: What Bernie Sanders Means When He Talks About Wealth and Income Inequality [256*3]
INCOME INEQUALITY - 1700 - 2010Click thumbnail to view full-size
WEALTH INEQUALITY 1700 - 2010Click thumbnail to view full-size
What is Wealth and Income Inequality?
FIRST, LET ME POINT OUT THERE IS A DIFFERENCE between Wealth and Income. While it is a little more complicated than this, simply put Wealth is what you possess and Income is what you earn; there can be inequality with one, the other, or both ... or neither (but very unlikely). Income itself comes in two forms: 1) that earned by wages and its substitutes and 2) that earned from wealth (capital) such as rent, dividends, and the like.
What is inequality? It is the maldistribution of wealth or income throughout a society or between societies. Inequality, in and of itself, is neither a good nor a bad thing; it is just a state of being. Further, history tells us that in any society where wealth and income are 1) not regulated (1710 France) or 2) overly regulated (Soviet Union), each will find a steady-state where 10% or less of society owns 90% and there is no middle class.
Even when wealth and income is reasonably regulated there is going to be disparity, this can be proven, but it is a disparity which most people expect and can accept, as we did in the 1960s. It is when you get to extremes of inequality where problems arise. That goes both ways, by the way; too much equality or too much inequality can cause problems in most societies. In the 1770s, both extreme income and wealth inequality was one of the major contributing factors to the French Revolution ... and the loss of many heads. So, as you can see, inequality can be serious business.
What follows will first be a discussion of how inequality comes into being, using a simple example. Then we look at one way to measure it so that it can be compared over time. After that, we consider the "So What?" question. The initial example was not "real world" and presented how inequality evolves without anybody helping (more or less) but that is not the norm in society, so now we look at how society insures inequality above and beyond its "natural" evolution. Finally, we consider what needs to be done about it.
So, How Does Inequality Come About?
IN THEORY, VERY SIMPLY REALLY, BUT THE MECHANICS ARE VERY COMPLEX. This section presents a very simple example of how Wealth Inequality comes about with no one really trying to make it happen; this is a real world fact of life for which there is much empirical evidence. Obviously, there are many other ways wealth inequality expresses itself, but it is not so easily explained, but, it is nevertheless still quite real. More on that in the following sections.
Let me start this example by creating an artificial world, one that contains just five people (that makes my arithmetic a lot easier). None of these people actually work, they just earn their money from capital gains. Don't worry about external things like food, entertainment, etc., our focus is just their wealth and their income from it.
Now, let's give them some wealth, meaning assets; in this case cash. Two of our people only have $1,000 each in the bank, two others have $100,000 each, and one has $1,000,000. This means the "National Wealth" in our little world is $1,202,000. The inequality is obvious, but is it good or bad? Who knows, but it isn't important now.
OK, let's add some capital income inequality. Let us assume our population's total income derives solely from interest on the money they have in the bank. In real life, each level of savings earns different maximum interests rates; the reason is it is a function of the quantity of money available to invest. For all sorts of different reasons, a $100,000investment will earn a higher interest rate than a $1,000 investment. Likewise, a $1,000,000 will earn more than the other two. For our purposes I will use 5% ($1,000), 8% ($100,000), and 10% ($1,000,000). A final assumption is that each person reinvests 100% of the interest; don't worry if they starve to death in this model, I will feed them in the next one to make a different point. Also, there is a measure inequality where 0 = no inequality and 1 = one person in the population holds all of the wealth. This is called the GINI Coefficient. So, to begin with, the GINI Coefficient is 0.68.
At the end of the first year, assuming annual payments, that means:
- Each person with $1,000 in net worth received $50
- Each person with $100,000 in net worth received $8,000
- Each person with $1,000,000 in net worth received $100,000
Through nobody's fault but the way the system works, the increase in inequality becomes apparent. An equal world would have had the interest rates (5, 8, and 10%) for each wealth lever be the same (5 OR 8 OR 10%), regardless of the amount of wealth. This would mean each would have received the same return on their investment; but that is not real life, nor should it be.
If we let this go on for just ten years, we end up with:
- Each person with $1,000 in net worth received $629 (Net worth $1,629)
- Each person with $100,000 in net worth received $115,829 (Net worth $215,829)
- Each person with $1,000,000 in net worth received $1,593,742 (Net worth $2,593,742)
(The beauty of compounding!) Obviously, the disparity has greatly increased leading to even more income and wealth inequality. Again, no moral judgement at this point, but you can see how we are approaching the top tier owning 86%, up from 83%, in ten years. This results in a GINI Coefficient of 0.71, signifying more inequality.
By year 100, our millionaire will now own 97% of all wealth, without lifting a finger. There are many people in America who have no problem with this state of affairs, even when we consider the next example.
Now They Must Eat, So Some Must Work
For this example, I'm not going to let our population starve to death. Instead, I will assume they spend the $31,000/yr needed for the very basic necessities of life (see the Hub on poverty, it's actually between $32 and $37K now). To do this, we will assume they will take 1% of their capital income and put towards, the $31,000; for the remainder, they will have to go to work.
I will use the same 5% ($1,000), 8% ($100,000), and 10% ($1,000,000) from the previous example. A final assumption is that each person reinvests all but 1% of the interest they earn. Base on these assumptions and ground rules (it has been a long time since I used that terminology), here is what we get:
At the end of the first year, assuming annual payments, that means (Table 1 shows how this works):
- Each person with $1,000 in net worth received $40 in interest to be reinvested and needed an additional $30,960 in labor income.
- Each person with $100,000 in net worth received $7,000 in interest to be reinvested and plus $30,000 in labor income.
- Each person with $1,000,000 in net worth received $90,000 in interest to be reinvested and only $21,000 more in labor income.
Using the new 4%, 7%, and 9% figures, here is what our now barely fed population has after ten years:
If we let this go on for just ten years, we end up with:
- Each person with $1,000 in net worth received $460 (Net worth $1,460)
- Each person with $100,000 in net worth received $96,714 (Net worth $196,714)
- Each person with $1,000,000 in net worth received $1,367,364 (Net worth $2,367,364)
This also has a GINI coefficient of 0.71.
In four more years, the person starting out with a $1,000,000 can stop working again, and begin eating better and better until satiation. It won't be long after that, the once millionaire will be living in the lap of luxury. At this point, the millionaire can set back and let the money roll in, in larger and larger amounts until they once again control well over 90% of all wealth.
GINI INDEX GRAPH
How Do You Measure Inequality? The GINI Index.
I HAVE BROUGHT UP THE GINI INDEX or coefficient in several other hubs and have already put it to use again in this one. The GINI Index (or coefficient) measures relative dispersion such that if whatever we are considering is evenly dispersed amongst the population, then the Index would be zero and if it was concentrated to just one person in the population, the Index would be very close to one.
In my made up world the initial Wealth Gini Index is 0.68, which is very skewed toward lots of inequality. After 10-years of accumulation the wealth gini index in now 0.71, meaning inequality grew. For income (wages plus interest), the equivalent figures would be 0.716 in the first year and 0.723 after 10 years. After 20 years, it would be .731 (compare to reality in America, which is 0.48). Clearly, this also demonstrates that as time goes on income inequality progressively gets worse, without anyone lifting a finger to make it happen.
So What, Who Cares, That's Life Isn't It?
WELL, YES IT iS, AS FAR AS IT GOES; but it can have severe consequences, as the French aristocrats found out in 1789. In our little world, it has no consequences at all because the five people who populate it, by assumption, are self-sufficient. Consequently, each can go on earning their share of the pie until the cows come home and it will not have any social consequence. But in real life, where 95% of the population is not self-sufficient (meaning they can't survive on just their wealth alone), it can have enormous consequences.
Even in my little made up world where inequality naturally occurs, if you relax the "self-sufficiency" assumption and now assume each person must survive on the interest they make and prices start to rise for some reason, our small net worth citizens will soon be priced out of the market and may revolt or die.
Capital in the 21st Century
Capitalism = Inequality
KARL MARX'S OBSERVATION THAT CAPITALISM leads to inequality is quite correct; its just that his answer to the problem is very wrong. Thomas Piketty lays out in his latest book, Capitalism in the 21st Century, that, barring any intervention, Capitalism is inherently 1) unstable and 2) leads inexorably to massive wealth and income inequality; it is simply in the nature of the beast as you can see from my simple examples above. This isn't to say that you want to throw the baby out with the bathwater and do away with capitalism ... hardly; it is still the greatest thing since sliced bread; it just needs a little TLC by the government to succeed in a big way.
In other hubs I get into the details of why unregulated capitalism is doomed to fail from the get-go, so let me give you the short version and then I will expand on the inequality aspect. Those in America who are a proponent of "laissez-faire" capitalism, meaning "government, keep your damn hands off the American Dream, it works fine on its own". simply don't understand the dynamics and pitfalls of capitalism. They believe in the myths that, left alone capitalism provides for:
- free and fair competition for services, products, and labor
- barriers to most segments of service and industry are low allowing anyone with the talent and willpower to excel
- the laws of Supply and Demand works in the short, mid, and long-term ... always
- Prices of goods, services, and labor are not sticky
- Everybody is honest
- All labor and business owners are, at the same time, altruistic and self-serving
- The profit motive almost always lead to the most efficient and effective decisions between alternatives
Unfortunately, capitalism doesn't provide for any of those things - not one; they simply don't exist in the real world. And because they don't, left on its own capitalistic system is doomed from the start.
For example, let us assume for the moment that on Day One, everything in the world is Perfect; for a split second all of those points listed above were true at the same time. The first question I would ask is why would any of them remain true a moment later? And what happens if any one of those things change for the worse? The answer is inequality begins to raise its ugly head, whether by design or just as a function of how capitalism works.
Let's take the implications of numbers 6 and 7. In the real world, we know those are not even close to being true. Labor cannot afford to be altruistic and most business owners incorrectly think being altruistic is not good for the bottom line, so they aren't. Further, as time has marched on, the planning horizon of business has grown much shorter which leads to worse long-term choices among alternatives because the short-term gain seems too attractive to pass up ...even though it might sink the business later on. One outcome of this, which has been observable since the 2000s, is a reduction in wages of mid-level management and below along with an increase in salaries of senior management (save for the temporary impact of the Great Recession). The growing gap in wealth and income between the upper classes and the shrinking middle and growing lower classes is palpable as a result.
Entry barriers into the market place are growing in the major industries as industries once again consolidate into oligopolies and monopolies. Competition is no longer free or fair in many economic sectors. This is because the cost of entry is so high and the chance of profit so low due to the pricing structure of the monoliths who control the market and, in many cases, the suppliers; the average American has no hope of striking out on their own in these circumstances. Gone are the days of the opening a corner grocery whose profits could feed your family; you will be lucky to get a minimum wage job at the Walmart down the street.
The fact that many businesses, especially large corporations, are not honest is well known. That, in and of itself, leads to a large degree of inequality and to the ultimate demise of capitalism. The combination of dishonesty, short-term thinking, profit motive, greed (which is neither good nor bad, it just is) all lead to one thing ... the concentration of wealth in fewer and fewer hands. That is, of course, unless society through its government representatives intervene.
At some point in time, if left unchecked, capitalism will collapse as those with the wealth and power simply take over the economic system and keep everybody out of their part of the market; you see that in many countries today. There will be capitalism in name only. More than likely, their influence with government and the election process will be total and despotism is the result. That was where unrestrained capitalism ended up in 1913, and that is where are headed again. While oligopolies and monopolies didn't necessary control government or elections, not that they didn't trey, but they (J.P. Morgan) were strong enough to effectively assume control of the financial market in 1900 and put in place a private version of TARP in order to bring a recession similar to our 2008 one under control. It was the financiers ability to do that which scared Congress and the President enough to finally taking control.
The answer is simple, however. Regulate 1) the financial sector tightly, but fairly, and 2) regulate the remainder as much as needed in order to guarantee the citizens right and ability to participate in commerce without fear of unfair barriers to that participation. In that way, the self-destructive forces within capitalism can be mitigated or eliminated.
DISTRIBUTION OF INCOME AND CAPITAL OWNERSHIP
CAPITAL OWNERSHIP %
CAPITAL OWNERSHIP $
1700 - 1913
1700 - 1913
Tip of the Iceberg
THIS IS ONLY THE TIP OF THE ICEBERG when considering the mechanisms and ramifications of both wealth and income inequality. It destructive impact reaches far and wide, it ultimately reduces GDP growth, and makes average people feel like the serfs of old. Unfortunately, the solutions are totally unacceptable to those on the Right who even acknowledge inequality exists or that it is bad. I feel it is only a matter of time until the clock is set back to 1950 from another Great Depression.
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© 2015 My Esoteric
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