On the 13th of April 2010, the Dalai Lama tweeted:
Economic inequality, especially that between developed and developing nations, remains the greatest source of suffering on this planet.
In early 2011, the authoritative Economist magazine and the WEF in Davos, both perceived global inequality as a major global problem. (Although the Economist proposed a quick-fix: increase social mobility).
The complex causes and possible remedies can perhaps be debated endlessly, but what is clear are the empirical facts. Income and wealth are distributed according to a very specific probability distribution, called scaling law, power law, fat tailed distribution or 80-20 rule. To put it pithily: nearly all have very little and very few have very much. This was already observed by V. Pareto 1906 in and still holds today.
For scientists, the emergence of scaling law distributions is nothing uncommon (although there is no conclusive understanding of their origins). In fact, a huge range of natural phenomena display scaling laws: from physics, biology, earth and planetary sciences, computer and network sciences, demography and social sciences to linguistics. It seems, that every complex system in nature, i.e., systems comprised of many interacting or interconnected parts, is associated with scaling law distributions. So we shouldn't take economic inequality too personal, but understand it as a systemic "feature".
What if income or wealth would be distributed according to a normal distribution (also called Gaussian distribution or Bell curve)? Like the height of people or IQ? We would see most incomes or wealth scattered around a global average, while few are very poor and very rich. In contrast, if height would be distributed like a scaling law, things would look like this graph: most people would be 6'7'' or smaller, while very few are in fact larger than hundreds of feet:
OK, you get the idea, so lets look at...
Some Numbers
David Tepper, at Appaloosa Management, personally earned an estimated US$4 billion in 2009.
On the other side, we have an estimated 5.15 billion people, or roughly 80% of the world's population, living on US$10.00 a day or less in 2005.
Or in 2002, an estimated 17% of the world population lived on US$1 or less per day. Visualize this: territory size shows the proportion of all people living on less than or equal to US$1 in purchasing power parity a day.
From worldmapper.org (check out there many maps visualizing various statistics).
For the poor, there is another pressing issue, compounding the problem: the poorest 2 billion people spend 50%-70% of their income on food.
The World Institute for Development Economics Research reported in 2008:
On the other side, we have an estimated 5.15 billion people, or roughly 80% of the world's population, living on US$10.00 a day or less in 2005.
Or in 2002, an estimated 17% of the world population lived on US$1 or less per day. Visualize this: territory size shows the proportion of all people living on less than or equal to US$1 in purchasing power parity a day.
For the poor, there is another pressing issue, compounding the problem: the poorest 2 billion people spend 50%-70% of their income on food.
The fact that inequity is described by scaling law distributions also means that it has fractal properties: you can zoom in and still find the same kind of inequality at all scales.
The World Institute for Development Economics Research reported in 2008:
The wealth share estimates reveal that the richest 2 per cent of adult individuals own more than half of all global wealth, with the richest 1 per cent alone accounting for 40 per cent of global assets. The corresponding figures for the top 5 per cent and the top 10 per cent are 71 per cent and 85 per cent, respectively. In contrast, the bottom half of wealth holders together hold barely 1 per cent of global wealth. Members of the top decile are almost 400 times richer, on average, than the bottom 50 per cent, and members of the top percentile are almost 2,000 times richer.
According to the latest Global Wealth Report from Credit Suisse, the people with a household net worth of $1 million or more represent less than 1% of the world’s population but own 38.5% of the world’s wealth: about $89 trillion. That’s up from a share of 35.6% in 2010. Their wealth increased by about $20 trillion last year. In fact, the wealth of millionaires and billionaires grew 29% last year. From the Wall Street Journal's blog.
The Economist notes in the article The 99 percent:
A report from the Congressional Budget Office (CBO) points out that income inequality in America has not risen dramatically over the past 20 years—when the top 1% of earners are excluded. With them, the picture is quite different.
In May 2011, Vanity Fair published an article written by Joseph Stiglitz, an economics Nobel Laureate, called Of the 1%, by the 1%, for the 1%:
The upper 1 percent of Americans are now taking in nearly a quarter of the nation’s income every year. In terms of wealth rather than income, the top 1 percent control 40 percent. Their lot in life has improved considerably.
While the top 1 percent have seen their incomes rise 18 percent over the past decade, those in the middle have actually seen their incomes fall. For men with only high-school degrees, the decline has been precipitous—12 percent in the last quarter-century alone. All the growth in recent decades—and more—has gone to those at the top.
Stiglitz goes on to note:
Economists long ago tried to justify the vast inequalities that seemed so troubling in the mid-19th century—inequalities that are but a pale shadow of what we are seeing in America today. The justification they came up with was called “marginal-productivity theory.” In a nutshell, this theory associated higher incomes with higher productivity and a greater contribution to society. It is a theory that has always been cherished by the rich. Evidence for its validity, however, remains thin.
Those who have contributed great positive innovations to our society, from the pioneers of genetic understanding to the pioneers of the Information Age, have received a pittance compared with those responsible for the financial innovations that brought our global economy to the brink of ruin.
First, growing inequality is the flip side of something else: shrinking opportunity.
The more divided a society becomes in terms of wealth, the more reluctant the wealthy become to spend money on common needs. The rich don’t need to rely on government for parks or education or medical care or personal security—they can buy all these things for themselves.
But one big part of the reason we have so much inequality is that the top 1 percent want it that way. The most obvious example involves tax policy. Lowering tax rates on capital gains, which is how the rich receive a large portion of their income, has given the wealthiest Americans close to a free ride.
America’s inequality distorts our society in every conceivable way. There is, for one thing, a well-documented lifestyle effect—people outside the top 1 percent increasingly live beyond their means. Trickle-down economics may be a chimera, but trickle-down behaviorism is very real
Analysis of economic networks have revealed that national power-structures are self-preserving: even in the face of corporate governance reforms and globalization, they do not break up. (B. Kogut and G. Walker, "The Small World of Germany and the Durability of National Networks", American Sociological Review, 2001; R. Corrado and M. Zollo, "Small worlds evolving: governance reforms, privatizations, and ownership networks in Italy", Industrial and Corporate Change, 2006)
Our recent analysis of ownership networks has shown:
- In markets with many widely held corporations (mostly in Anglo-Saxon countries), the observed local distribution of ownership, meaning shareholder democracy, actually goes hand in hand with a global concentration of ownership (and control), only visible from the bird's-eye view given by the network perspective, where the ownership and control ends up in the same few hands.
- About 750 top economic agents in the global ownership network of ~600k nodes potentially control 80% of the value (operating revenue) of the ~43k transnational corporations.
- Of these, the top 50 already have nearly 40%.
- The tiny core of the network, comprised of ~1300 nodes, holds ~40% of the potential control.
- There are about 150 top agents in the core, potentially controlling about 38%.
D. Braha from the New England Complex Systems Institute (NECSI), when interviewed about our network study by New Scientist, said:
The Occupy Wall Street claim that 1 per cent of people have most of the wealth reflects a logical phase of the self-organising economy.
(Personally, I feel the word "logical" is perhaps a bit too strong.) However, he "suspects they [the companies in the tiny core of the ownership network that have a disproportionately large amount of control] will compete in the market but act together on common interests. Resisting changes to the network structure may be one such common interest."
So, What About Greed Then?
Michael Lewis, the author of Liar's Poker, wrote:
Not for a moment did I suspect that the financial 1980s would last two full decades longer or that the difference in degree between Wall Street and ordinary life would swell into a difference in kind. I expected readers of the future to be outraged that back in 1986, the C.E.O. of Salomon Brothers, John Gutfreund, was paid $3.1 million; [...] What I didn’t expect was that any future reader would look on my experience and say, “How quaint.”
Especially recalling Mr. Tepper's 4 billion from above. Lewis goes on to describe his personal experience in the financial industry:
To this day, the willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grownups remains a mystery to me. I was 24 years old, with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall.
I stumbled into a job at Salomon Brothers in 1985 and stumbled out much richer three years later, and even though I wrote a book about the experience, the whole thing still strikes me as preposterous—which is one of the reasons the money was so easy to walk away from. I figured the situation was unsustainable. Sooner rather than later, someone was going to identify me, along with a lot of people more or less like me, as a fraud. Sooner rather than later, there would come a Great Reckoning when Wall Street would wake up and hundreds if not thousands of young people like me, who had no business making huge bets with other people’s money, would be expelled from finance.Again from here. Of course, this is all debatable, from his sincerity, to possible hidden agendas, to being biased by wanting to write a popular book.
However, these things definitely don't help:
Take the now-infamous example of the recently ousted Merrill Lynch chief John Thain, who not only splurged on his office decor [over $1 million] but also had the audacity to propose a $10 million bonus for himself. In recognition of what? A year's work in which the company continued to make bad business decisions, lost about 80 percent of its value, sold itself to Bank of America to stave off possible collapse and appears to have seriously damaged its buyer's franchise?
Bank of America ($45 billion in bailout money) sponsored a five-day "NFL experience" at the Super Bowl; Wells Fargo ($25 billion in bailout funds) was planning 12 nights in Las Vegas for select employees.From You Can Cap The Pay, But The Greed Will Go On, Washington Post, February 8, 2009.
For Dow Kim, 2006 was a very good year. While his salary at Merrill Lynch was $350,000, his total compensation was 100 times that — $35 million.
The difference between the two amounts was his bonus, a rich reward for the robust earnings made by the traders he oversaw in Merrill’s mortgage business. [...]
But Merrill’s record earnings in 2006 — $7.5 billion — turned out to be a mirage. The company has since lost three times that amount, largely because the mortgage investments that supposedly had powered some of those profits plunged in value.
Unlike the earnings, however, the bonuses have not been reversed.
Such practices are perhaps a reason why some people working in the finance industry turned away in disgust. Like Michel Lewis, or Geraint Anderson, a former investment banker, who wrote a book about his personal experiences, called City Boy: Beer and Loathing in the Square Mile. Some of the reviews:
- London’s pernicious financial world reveals itself in all its ugliness.
- As a primer to back-stabbing, bullying, drug-taking, gambling, boozing, lap-dancing, this takes some beating...a necessary and valuable boo.
- Engaging, timely and important...an effective indictment of the narcissism and decadence of City life.
Recently, I read a comment where the person asked the question, of how much of the risk appetite of investment banking was fueled by cocaine. In Italy, the government is currently debating drug tests for traders. There is allegedly a new study correlating market volatility with drug abuse among traders (the news article claiming this).
The story of Andrew Lahde is also telling. As founder and manager of a small
California hedge fund he came into the spotlight in 2007,
after his one-year-old fund returned 866% betting against the
subprime collapse. In 2008 he closed his fund and wrote a "goodbye" letter to his investors. Some excerpts:
I was in this game for the money. The low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy, only ended up making it easier for me to find people stupid enough to take the other side of my trades.
I now have time to repair my health, which was destroyed by the stress I layered onto myself over the past two years, as well as my entire life -- where I had to compete for spaces in universities and graduate schools, jobs and assets under management -- with those who had all the advantages (rich parents) that I did not. May meritocracy be part of a new form of government, which needs to be established.
First, I point out the obvious flaws, whereby legislation was repeatedly brought forth to Congress over the past eight years, which would have reigned in the predatory lending practices of now mostly defunct institutions. These institutions regularly filled the coffers of both parties in return for voting down all of this legislation designed to protect the common citizen. This is an outrage, yet no one seems to know or care about it.
Others have taken the same line in asking how deserved and legitimate the super-high salaries of top earners are. For instance George Monibot in the Guardian:
If wealth was the inevitable result of hard work and enterprise, every woman in Africa would be a millionaire. The claims that the ultra-rich 1% make for themselves – that they are possessed of unique intelligence or creativity or drive – are examples of the self-attribution fallacy.
Moreover, the accuracy of forecasts of financial experts is highly doubtful and the need for advice from experts may be more a psychological than practical thing. "We believe in experts in the same way that our ancestors believe in oracles." Taken from this Economist article.
The University of St. Gallen in Switzerland, considered to be one of the leading business schools in Europe, has a lecture on the emergence of new markets, where the increasing importance of innovation is discussed. One of the topics of the course is about leadership, power and conflict:
Innovation is not generated in the power center (management) of a corporation, but instead, exactly by such employees, who diverge from the prevailing mindset of the company.(From the syllabus, translation mine.) And what does this say about income inequality, Gini coefficients, and who gets payed how much for doing what exactly?
And does high monetary compensation really motivate people? Make us creative and innovative? See for instance the youtube video called Drive: the surprising truth about what motivates us. (Thanks Ben for your comment reminding me about this.)
Finally, psychologists have also noted the Power Paradox:
[...] studies also show that once people assume positions of power, they’re likely to act more selfishly, impulsively, and aggressively, and they have a harder time seeing the world from other people’s points of view. This presents us with the paradox of power: The skills most important to obtaining power and leading effectively are the very skills that deteriorate once we have power.
Greg Smith, Goldman Sachs executive director and head of the firm’s United States equity derivatives business in Europe, the Middle East and Africa, recently resigned. In an opinion piece in the New York Times, he heavily criticizes the firm’s ethical culture and moral conduct:
The firm changed the way it thought about leadership. Leadership used to be about ideas, setting an example and doing the right thing. Today, if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence.
Moreover, recent studies have indicated that the higher the social class and the wealthier the individuals are, the higher the tendency of unethical behavior and the less generous, charitable, trusting and helpful they proved to be. In general bad behavior appears to be spurred by greed. See links here.
Things Are Changing
Lahde's words from 2008 ring very familiar with the current Occupy Wall Street movement and their mantra "we are the 99%". Also Joseph Stigliz' analysis from May this year, mentioned above, continues and has an uncanny, prophetic feel to it:
Governments have been toppled in Egypt and Tunisia. Protests have erupted in Libya, Yemen, and Bahrain. The ruling families elsewhere in the region look on nervously from their air-conditioned penthouses—will they be next? [...] As we gaze out at the popular fervor in the streets, one question to ask ourselves is this: When will it come to America? In important ways, our own country has become like one of these distant, troubled places.
Americans have been watching protests against oppressive regimes that concentrate massive wealth in the hands of an elite few. Yet in our own democracy, 1 percent of the people take nearly a quarter of the nation’s income—an inequality even the wealthy will come to regret.
Of all the costs imposed on our society by the top 1 percent, perhaps the greatest is this: the erosion of our sense of identity, in which fair play, equality of opportunity, and a sense of community are so important.
It is this sense of an unjust system without opportunity that has given rise to the conflagrations in the Middle East: rising food prices and growing and persistent youth unemployment simply served as kindling. With youth unemployment in America at around 20 percent (and in some locations, and among some socio-demographic groups, at twice that); with one out of six Americans desiring a full-time job not able to get one; with one out of seven Americans on food stamps (and about the same number suffering from “food insecurity”)—given all this, there is ample evidence that something has blocked the vaunted “trickling down” from the top 1 percent to everyone else. All of this is having the predictable effect of creating alienation.
However, there are some rich and super-rich who see this predicament. In this "revolution of the rich", they are calling for higher taxes for themselves. In the US, billionaire Warren Buffet wrote an op-ed article in the New York Times where he sarcastically commented:
These and other blessings are showered upon us [the super-rich] by legislators in Washington who feel compelled to protect us, much as if we were spotted owls or some other endangered species. It’s nice to have friends in high places.and claims to pay half the percentage in taxes as his employees.
In Germany the musician Marius Müller-Westernhagen proclaimed
Taxes do not make the wealthy poor.in an ongoing debate, in which some of millionaires have signaled their support of higher taxes for the rich. Similar advances can be seen in France, where 16 top managers of big French companies have signed a petition supporting higher taxes for the rich. More here.
The most extreme scaling law distribution of wealth is one person having everything. The most extreme Gaussian distribution, a delta function, would mean that everyone has exactly the same wealth. In-between, there is a multitude of possibilities. What do you think is equality?
But is this all really the right and relevant way to globally asses the well-being of the world's population? Shouldn't the focus be more related to happiness (which, admittedly, is hard to define) and its pursuit? For instance, something like a happiness index? The obvious answer is: no of course not, financial hardship always results in unhappiness. In contrast, how many people pursue demanding careers, make personal sacrifices and get high compensation actually because they believe this will increase their level of happiness?
But new insights coming from neuro-sciences and behavioral economics have shown that happiness can be very context dependent, constructed and sometimes quite independent from the external world:
- Tasting the same wine three times, but experiencing more pleasure because you thought one was expensive: Marketing actions can modulate neural representations of experienced pleasantness, PNAS, 2008.
- Feeling pain depends on what your beliefs are about the current experience: believing you are deliberately being harmed intensifies the experience of pain. Paul Bloom's TED talk the origins of pleasure.
- Daniel Gilbert's TED talks why are we happy? why aren't we happy? and exploring the frontiers of happiness.
- Daniel Kahneman's TED talk the riddle of experience vs. memory.
- Matthieu Ricard's TED talk habits of happiness.
My sense is that a lot of people in finance hate what they do. There's no passion. But they are trapped by the money.
Recently, the Economist wrote
So levels of income are, if anything, inversely related to felicity. Perceived happiness depends on a lot more than material welfare.
Just sayin'...
PS
More on neuro-science:
- the brain: alien processes running under the hood (part i)
- the brain: our two cognitive minds (part ii)
