World Politics News   Articles for World Politics Course

Scientific American has published a fascinating article entitled “Is Inequality Inevitable?” Wealth Inequality is increasing in almost every country on the planet:

“Wealth inequality is escalating at an alarming rate not only within the U.S. but also in countries as diverse as Russia, India and Brazil. According to investment bank Credit Suisse, the fraction of global household wealth held by the richest 1 percent of the world’s population increased from 42.5 to 47.2 percent between the financial crisis of 2008 and 2018. To put it another way, as of 2010, 388 individuals possessed as much household wealth as the lower half of the world’s population combined— about 3.5 billion people; today Oxfam estimates that number as 26. Statistics from almost all nations that measure wealth in their household surveys indicate that it is becoming increasingly concentrated.”

It is difficult to explain the process of concentrating wealth in a market economy if one accepts the traditional defense of market capitalism. The market is supposed to be a completely neutral mechanism, rewarding only those who produce goods and services with high efficiency for which there is a high demand. The implicit assumption is that all persons have equal freedom to make good choices, and that assumption leads to a conclusion that there should be no bias in the allocation of rewards for good choices. That assumption does not square with the actual distribution of rewards in a market economy.

There are many ways to account for the seemingly systematic bias in market economies. Race and gender biases undermine the assumption that all persons have equal freedom. There are also political biases in the creation of laws and regulations that favor some individuals over others (this explanation is the one I prefer). But the article in Scientific American makes the interesting argument that the bias in market economies is a feature of the market itself: in other words, inequality is inherent in any economy in which transactions between individuals occur. Even more interesting is the possibility that the inherent bias argument resonates with some theories in physics.

The explanation is actually simple but requires an extended quote from the article.

” To understand how this happens, suppose you are in a casino and are invited to play a game. You must place some ante—say, $100—on a table, and a fair coin will be flipped. If the coin comes up heads, the house will pay you 20  percent of what you have on the table, resulting in $120 on the table. If the coin comes up tails, the house will take 17  percent of what you have on the table, resulting in $83 left on the table. You can keep your money on the table for as many flips of the coin as you would like (without ever adding to or subtracting from it). Each time you play, you will win 20 percent of what is on the table if the coin comes up heads, and you will lose 17 percent of it if the coin comes up tails. Should you agree to play this game?….

“If our goal is to model a fair and stable market economy, we ought to begin by assuming that nobody has an advantage of any kind, so let us decide the direction in which ∆w is moved by the flip of a fair coin. If the coin comes up heads, Shauna gets 20  percent of her wealth from Eric; if the coin comes up tails, she must give 17  percent of it to Eric. Now randomly choose another pair of agents from the total of 1,000 and do it again. In fact, go ahead and do this a million times or a billion times. What happens?

“If you simulate this economy, a variant of the yard sale model, you will get a remarkable result: after a large number of transactions, one agent ends up as an “oligarch” holding practically all the wealth of the economy, and the other 999 end up with virtually nothing. It does not matter how much wealth people started with.It does not matter that all the coin flips were absolutely fair. It does not matter that the poorer agent’s expected outcome was positive in each transaction, whereas that of the richer agent was negative. Any single agent in this economy could have become the oligarch—in fact, all had equal odds if they began with equal wealth. In that sense, there was equality of opportunity. But only one of them did become the oligarch, and all the others saw their average wealth decrease toward zero as they conducted more and more transactions. To add insult to injury, the lower someone’s wealth ranking, the faster the decrease.”

There is a great deal of new information (in the last ten years) that suggests that inequality is an inherent feature of any market economy. For example, Thomas Piketty in his book, Capital in the 21st Century, looked at income and wealth distribution over an extended period of time and found that the return to capital was about 5% a year whereas the return to labor was about 3% a year. That empirical approach confirms an inherent bias, but only among two basic groups: sellers of labor and holders of capital. That conclusion is not inconsistent with the argument in Scientific American, but it is more limited. In both cases, however, the effective conclusion is that if society decides that growing inequality is a serious problem, then the solutions must necessarily involve non-market approaches:

“Moreover, only a carefully designed mechanism for redistribution can compensate for the natural tendency of wealth to flow from the poor to the rich in a market economy. Redistribution is often confused with taxes, but the two concepts ought to be kept quite separate. Taxes flow from people to their governments to finance those governments’ activities. Redistribution, in contrast, may be implemented by governments, but it is best thought of as a flow of wealth from people to people to compensate for the unfairness inherent in market economics. In a flat redistribution scheme, all those possessing wealth below the mean would receive net funds, whereas those above the mean would pay. And precisely because current levels of inequality are so extreme, far more people would receive than would pay.”

That inequality is not “random” is nicely captured by a map of income inequality produced by the International Monetary Fund (IMF). It is a map of inequality in the US and just a quick glance confirms that there are clear departures from a random distribution of income in the US.