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Yard Sale – Part 2

January 25, 2011 by Blue Ridge Leader filed under Columns, Sustainable Planet No Comments

“A guiding principle is that new ideas come from profound analysis of simple models – thinking deeply of simple things.” Ray Pierrehumbert, Principles of Planetary Climate, Cambridge University Press, 2010.

“Misery and poverty are frequently confused, because they are close – close, but located on either side of a limit. On one side, economic life is not assured; on the other side, it is assured. Beneath that limit, there’s misery, no certainty of a viable life, constant risk; above the limit, the risk stops, and poor or rich, there is assurance. Immediately above the limit is poverty, and above that are the successive zones of affluence. All below is misery; poverty is only a little above; thus the two are close in quantity, closer than much affluence is to poverty. Judging only by quantity, wealth is much further from poverty than poverty is from misery; but between poverty and misery is a distinction in quality, in nature.” Charles Péguy, 1902 essay “De Jean Coste.” [1]

Tony Noerpel

Following Pierrehumbert’s advice, Last week I discussed the need for simple economic models and listed some requirements of a good model. I suggested Pareto’s Yard Sale model [2] to describe the observed migration of wealth from middle class and poor to the wealthy which seems to have occurred in all human civilizations since humans discovered the principle of private property and commerce. Prior to about 10,000 year ago, humans lived as small (between 75 and 150 individuals) egalitarian groups based on hunting and gathering with little concept of private property. With private property came trade and with trade came inequality. Pareto’s yard sale model suggests that inequality is inherently a result of commerce even without considering individual characteristics such as intelligence, good looks, shrewdness or dishonesty. In a large population some individuals will win big and many will lose. There have always been kings and emperors, dictators and captains of industry while most of the population either just got by or were slaves or destitute. According to the yard sale economic model with near certain probability somebody will become as wealthy as Bill Gates. The probability that Gates’ himself would turn out to be that person were probably rather low but because of his personal characteristics and inherited wealth certainly much higher than most people.

Another simple model that can show that this propensity of commerce to make somebody rich and many people poor is the Gambler’s Ruin problem from probability theory [3]. If two gamblers start with an equal amount of money and make a series of small wagers on the outcome of the toss of a fair coin, it is easy to show in closed form that there is a 50 percent probability that the first player will become bankrupted and a 50 percent probability that the second player will become bankrupted and zero probability that the game will continue without bankruptcy. This result is exact.

Further, we can calculate the probability of ruin for the two players if they start with unequal amounts of money. As you would expect, the player starting with the most money is most likely to win. The problem can be made more interesting by varying the relative probabilities of each player’s chances of winning. In other words, if the first player cheats a little bit, he may increase his probability of winning each coin toss slightly but he will increase the probability of the second player going bankrupt substantially.

At this time, 129 million Americans have health care problems which qualify as pre-existing conditions. All of these people could be denied coverage by their private-for-profit health insurance companies if the GOP/FOX/corporate elite succeed in overturning Obama’s health care plan [4]. Since health problems are the principle reason families are forced into bankruptcy in the United States, more American families will become vulnerable if Republicans were to succeed.

A recent report published by the Levi Institute finds that the top 1 percent of American households by income hold 37.1 percent of all wealth. The next 4 percent hold 27.9 percent. The next 15 percent hold 22.2 percent. The next 20 percent holds 10 percent of all wealth. The middle quintile holds 3.1 percent of all wealth. The bottom 40 percent of American households hold -0.8 percent of all wealth. 24.1 percent of all American households have negative net worth [5]. We see that wealth distribution is highly skewed and most Americans are vulnerable to economic failure even without suffering a debilitating injury or illness. The author of this report, Edward Wolff, concludes:

We can see how the rising debt of the middle class made them vulnerable to income shocks and set the stage for the mortgage crises of 2008 and 2009 and the resulting financial meltdown. The rapid decline in house prices over these two years (on the order of 24 percent) left many middle-class families (I estimate 16.6 percent of homeowners) “underwater” (greater mortgage debt than the value of their homes) and, coupled with a sharp spike in unemployment, unable (or unwilling) to repay their mortgage loans.”

Since the exploitation of fossil fuels, humans have been able to create new wealth faster than the natural migration of wealth from middle class and poor to the wealthy. In the recent past, this has led to increasing prosperity for a greater number of people but it has not eliminated misery. The large middle class was a positive feedback further increasing total wealth. This led to the evolution of modern democracies and the sense of fairness in which we all believe. A prudent and honorable goal of our society might be that no American has to live in misery and indeed we were on our way to achieving this goal. Poverty as defined by Péguy is fine so long as all Americans have equal opportunity, access to education, freedom from hunger and adequate health care and nobody is forced into misery. While some unequal wealth distribution may be acceptable and even desirable, vast accumulation of wealth is quite unnecessary and is harmful to the democratic process. Chief Justice William Brandeis wrote [6]: “We can have democracy in this country, or we can have great wealth concentrated in the hands of a few, but we can’t have both.” One of the mantras of the current economic crises is that failed banks were “too big to fail” and were subsequently bailed out. The lesson might have been that we should not let corporations become too big to fail or individuals to wealthy and powerful to corrupt, but we appear to have lost the opportunity to learn and apply this important lesson.

Naturally, extreme wealth is connected with extreme influence and power and of course that corrupts democracy. The Supreme Court’s Citizens United decision allowing unlimited funding of political campaigns by wealthy individuals and corporations probably signaled America’s transition from an oligarchy to a keptocracy [7]. Since Justices Scalia and Thomas met with the Koch Brothers who directly benefitted from the decision several times while the Supreme Court was dealing with the issue, they should have recused themselves. This is of course text book corruption.

Since the natural flow of wealth seems to be from poor to already wealthy and the natural evolution is to fewer and fewer larger and wealthier entities and individuals, we need a progressive income tax in order to redistribute wealth back to society. This is not a new idea but it is one that has been both successful and then successfully attacked by corporate elite, since the Reagan administration. We need to overturn the Supreme Court’s Citizen United decision and institute real campaign finance reform. We can learn from more successful democracies. We also need to decide, as a nation, whether or not we are going to tolerate misery, as we do today, or work to eliminate it. Since most of us are perhaps a single transaction away from misery, this might be the preferred choice of a majority of well informed citizenry.

I don’t suggest that excess wealth be taxed and then simply given to the poor. What I suggest is that it be taxed and then invested in the needs of society such as building schools, financing single payer federal health care, building mass transportation systems and of course funding research and development.

In part 3 of this series, I will describe Herman Daly’s ecological economic model of the economy and how it can show us how to invest in society in a sustainable way.

[1] http://www.energybulletin.net/stories/2011-01-17/decent-poverty-report-poverty-and-misery

[2] Brian Hayes, Follow the Money, American Scientist, Volume 90, Number 5
Page: 400, DOI: 10.1511/2002.5.400September-October, 2002 http://www.americanscientist.org/issues/pub/follow-the-money/2

[3] Ghahramani, Fundamentals of Probability, second edition, Prentice-Hall, 2000.

[4] http://www.washingtonpost.com/wp-dyn/content/article/2011/01/17/AR2011011702842.html

[5] http://www.levyinstitute.org/pubs/wp_589.pdf

[6] http://en.wikiquote.org/wiki/Louis_Brandeis

[7] http://www.commondreams.org/headline/2011/01/20-2

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