Global Wealth Redistribution and the Pareto Principle

[William Hung]

this distribution actually stems from statistical thermodynamics. it is what happens to any system where particles exchange conserved things. molecules exchange energy and momentum, which are conserved in collisions (interactions ) just like in an ideal economy people exchange money of fixed value and don't get to print money. what makes markets an interesting physics problem is that the conservation laws of statistical physics go out the window while retaining its tools .

the reason it follows a power law and not an exponential is likely due to perturbations from these real world factors. I'll pull up a report on this later I am traveling right now.

Interesting. Looking forward to your report.

And looking a bit further ahead, I wonder if this can somehow explain the power balance in world politics.

 

[Faiez]

As @Edison Chen detailed, the way the taxation system is set up (to favor capital with lower tax rates vs tax on income earned from labor) is certainly one major factor in the accumulation of wealth in a few hands.

I don't think so....

Investing in capital has risks. Doing a job has no risks. You never LOOSE money doing a job, but while investing as you make capital gains, you can as well make capital losses and there's no subsidy for capital losses. So the tax system is infact geared in favour of the low income guy, the guy who makes say USD50k/annum doing a job pays lower tax rate than the business man making millions in capital gains. Further more, the business man risks loosing money while working, the salaried guy never makes a negative income. How ever should the salaried guy go unemployed, can claim unemployment benefits to get back on his feat. So the entire system is infact geared towards serving the lowest income people, not the highest earners.

It's just class warfare that makes people think that the rich are taking money away from the poor...It's actually the other way around.

 

[LeveragedBuyout]

I don't think so....

Investing in capital has risks. Doing a job has no risks. You never LOOSE money doing a job, but while investing as you make capital gains, you can as well make capital losses and there's no subsidy for capital losses. So the tax system is infact geared in favour of the low income guy, the guy who makes say USD50k/annum doing a job pays lower tax rate than the business man making millions in capital gains. Further more, the business man risks loosing money while working, the salaried guy never makes a negative income. How ever should the salaried guy go unemployed, can claim unemployment benefits to get back on his feat. So the entire system is infact geared towards serving the lowest income people, not the highest earners.

It's just class warfare that makes people think that the rich are taking money away from the poor...It's actually the other way around.

Don't get me wrong, I'm as capitalist as the next guy, and I hate class warfare. Please let me elaborate on my previous point.

As @Edison Chen explained, at lower income levels, the tax system is unquestionably advantageous. Not only are taxes waived, but tax transfers mean that the tax rate is negative for much of the population. Furthermore, because of inflation, the tax threshold rises every year, so those with stagnant incomes will gradually fall into lower or zero tax brackets. This is a well-intentioned but misguided attempt to help the most disadvantaged, but instead it traps them in lower income levels, since it rewards low income, and punishes attempts to earn more (by removing tax transfers as income rises). On a practical level, I'm not certain the tax system helps the poor as much as people think.

As far as salary income being riskless, that's not true. You forgot to factor in inflation. On a real (inflation-adjusted basis), the middle class has done rather poorly over the last 30 years, because most of the gains from the productivity-led economic growth have gone to the capital holders. Capital holders can incur losses as well, but with a diversified portfolio, capital holders will make returns if they hold on for a long enough period of time (even in periods of hyperinflation, by holding "hard" currencies, real estate, etc.). The government does tax inflation, so returns must be in excess of inflation to build wealth, but that has not be a difficult task since Volcker.

And salaries employees are susceptible to unemployment and periods of non-earnings as well. Labor income is not guaranteed, either.

The point I am trying to get across is that it is an individual's savings that leads to wealth creation, because savings = capital formation. And because the returns on capital (with the caveats of diversification and time-frame) are higher than returns on labor, savings/investment is a key factor in building wealth. Since much of the population is unable to save (whether due to low earnings or poor impulse control), wealth accumulates in the hands of those who are able to save or already have capital.

 

[Faiez]

Don't get me wrong, I'm as capitalist as the next guy, and I hate class warfare. Please let me elaborate on my previous point.

As @Edison Chen explained, at lower income levels, the tax system is unquestionably advantageous. Not only are taxes waived, but tax transfers mean that the tax rate is negative for much of the population. Furthermore, because of inflation, the tax threshold rises every year, so those with stagnant incomes will gradually fall into lower or zero tax brackets. This is a well-intentioned but misguided attempt to help the most disadvantaged, but instead it traps them in lower income levels, since it rewards low income, and punishes attempts to earn more (by removing tax transfers as income rises). On a practical level, I'm not certain the tax system helps the poor as much as people think.

As far as salary income being riskless, that's not true. You forgot to factor in inflation. On a real (inflation-adjusted basis), the middle class has done rather poorly over the last 30 years, because most of the gains from the productivity-led economic growth have gone to the capital holders. Capital holders can incur losses as well, but with a diversified portfolio, capital holders will make returns if they hold on for a long enough period of time (even in periods of hyperinflation, by holding "hard" currencies, real estate, etc.). The government does tax inflation, so returns must be in excess of inflation to build wealth, but that has not be a difficult task since Volcker.

And salaries employees are susceptible to unemployment and periods of non-earnings as well. Labor income is not guaranteed, either.

The point I am trying to get across is that it is an individual's savings that leads to wealth creation, because savings = capital formation. And because the returns on capital (with the caveats of diversification and time-frame) are higher than returns on labor, savings/investment is a key factor in building wealth. Since much of the population is unable to save (whether due to low earnings or poor impulse control), wealth accumulates in the hands of those who are able to save or already have capital.

there's risks in investment. No risk is working for someone. You simply cannot argue with that.

As far as being "susceptible to unemployment and periods of non-earnings", a business man is exposed to same risks. He may get a return or he may not. Except the business man is worse off since he may actually LOOSE his principle. Does an accountant risk looses part of his accounting skills while working as an accountant ? Does he ever loose his principle investment or his asset (that is his accounting skills/education) ? A businessman risks loosing that with no safety net for him. If he goes out of business, nothing he can do.

Now your argument regarding the wealthy having higher returns since they own capital. Well what's stopping the lower income people from buying capital or starting their own businesses ? Is it not their own bad spending/saving habits (spending on alcohol, clubbing, buying stuff they shouldn't, credit cards etc etc) ? The wealthy also came from this same class.

A small number of highly passionate risk taking highly intelligent individuals that originated from the middle/low income class is what forms the bulk of the wealthy. They sacrificed their mediocre job's job security, put all their savings at risk (plus offcourse they saved, sacrificing "toys" they could have bought), spent massive amounts of time thinking and planning and coming up with something new, useful, progressive to sell to humanity, while they could have spent that same time like the rest of their class having fun, or even just sleeping (the future wealthy working late at night, sacrificing even a good night's sleep). At times risking their entire career (leaving well/decent paid jobs). All for what ? A mere chance at getting really really wealthy. And not even a sure chance. Just a tiny little chance in return for so much sacrifice. It's like a very expensive lottery ticket. You may make it or you may not and even loose what you had before you took the initiative to start a business etc.

And these socialists want to punish them for taking those risks and working harder or reward the lower income people for being stupid ?

If anything, capital gains tax should be a zero. And a flat personal income tax and offcourse significantly lowered sales and corporate taxes.

Why does the left only focus on raising taxes on the wealthy ? How about lowering the taxes on the poor even more ? Perhaps lowering sales taxes as well? It's primarily because the bulk of the tax still comes from the bulk of the society (the lower and the middle income). If anything, raising any more taxes on higher incomes would destroy businesses and people would flee USA as they already have...

Now I'm not a republican, but some part of their ideology does make sense...But then they talk of spending even more on defence and that's what doesn't make sense...and offcourse their general conservative-ness...

So libertarian is the right way ahead. Now I get it that you're also capitalist...but I just wanted to write all this somewhere.

 

[LeveragedBuyout]

Hmm, I'm not entirely sure we're arguing at this point, but just to make sure:

there's risks in investment. No risk is working for someone. You simply cannot argue with that.

Clearly you've never worked for a company that went bankrupt, or was engaged in questionable practices, or fired you. Working for someone else is all risk, because you don't control your own fate.

As far as being "susceptible to unemployment and periods of non-earnings", a business man is exposed to same risks. He may get a return or he may not. Except the business man is worse off since he may actually LOOSE his principle. Does an accountant risk looses part of his accounting skills while working as an accountant ? Does he ever loose his principle investment or his asset (that is his accounting skills/education) ? A businessman risks loosing that with no safety net for him. If he goes out of business, nothing he can do.

Yes, most capital holders earn labor income and investment income. They share the same labor income risks that non-investor laborers share, but they diversify their income stream with investment income. This diversification lowers their risk vs. the pure laborer. Entrepreneurship is just a hybrid form of investment and labor. The entrepreneur also does not lose his skills when his business fails, just like the accountant doesn't lose his skills when he is fired. But what about the difference between a worker who has unvested options in his company as part of his compensation vs. the entrepreneur? Your differentiation is not as clean as you present, because now you have a situation where both lose more than simply a salary when facing involuntary separation from their companies.

Now your argument regarding the wealthy having higher returns since they own capital. Well what's stopping the lower income people from buying capital or starting their own businesses ? Is it not their own bad spending/saving habits (spending on alcohol, clubbing, buying stuff they shouldn't, credit cards etc etc) ? The wealthy also came from this same class.

Yes, as I pointed out, there are two reasons why lower income earners do not invest. 1) Lack of sufficient earnings (I'm not delusional, a Wal-Mart janitor is never going to have enough capital to make a meaningful return) 2) poor behavior (buy a big-screen TV, buy a Starbucks coffee 3x a day, etc. instead of saving and investing).

A small number of highly passionate risk taking highly intelligent individuals that originated from the middle/low income class is what forms the bulk of the wealthy. They sacrificed their mediocre job's job security, put all their savings at risk (plus offcourse they saved, sacrificing "toys" they could have bought), spent massive amounts of time thinking and planning and coming up with something new, useful, progressive to sell to humanity, while they could have spent that same time like the rest of their class having fun, or even just sleeping (the future wealthy working late at night, sacrificing even a good night's sleep). At times risking their entire career (leaving well/decent paid jobs). All for what ? A mere chance at getting really really wealthy. And not even a sure chance. Just a tiny little chance in return for so much sacrifice. It's like a very expensive lottery ticket. You may make it or you may not and even loose what you had before you took the initiative to start a business etc.

Yes, agreed. Entrepreneurs deserve praise, not just for creating value, but for creating jobs that provide an income for others. Everyone sees the entrepreneurs that take risks and win, but they forget about, or overlook, those who took risks and failed. It's not easy, but because left-wingers don't work to earn money or take risks, they don't understand that.

And these socialists want to punish them for taking those risks and working harder or reward the lower income people for being stupid ?

Socialism is a cover for greed and jealousy. The justifications they present are irrelevant--it all comes down to a desire to expropriate the wealth created by others, and redistribute it to themselves.

If anything, capital gains tax should be a zero. And a flat personal income tax and offcourse significantly lowered sales and corporate taxes.

Yes, agreed. Republicans have been pushing for this since Goldwater, and failed and failed and failed. It's a great dream to have, but as long as humans remain greedy and jealous of others, I don't see it happening in a democracy.

Why does the left only focus on raising taxes on the wealthy ? How about lowering the taxes on the poor even more ? Perhaps lowering sales taxes as well? It's primarily because the bulk of the tax still comes from the bulk of the society (the lower and the middle income). If anything, raising any more taxes on higher incomes would destroy businesses and people would flee USA as they already have...

Ideally, yes. But as long as government is involved in illegitimate functions, like providing healthcare or social security, it needs to extract revenue to fund such activity, even if the method of extraction (progressive tax rates) is itself illegitimate.

Now I'm not a republican, but some part of their ideology does make sense...But then they talk of spending even more on defence and that's what doesn't make sense...and offcourse their general conservative-ness...

Realistically, there are four choices for the American voter: 1) vote Communist race-baiter (aka Democrat) 2) vote for parochial party with no chance of election (aka Libertarian party) 3) don't vote 4) vote Republican. As a conservative, there is no good choice for me, just the least bad choice, and that's #4. You should weigh the purity of your principles against the chances of realizing them the next time you decide not to vote Republican.

So libertarian is the right way ahead. Now I get it that you're also capitalist...but I just wanted to write all this somewhere.

In an ideal world, yes. But I have never understood why Libertarians believe we live in an ideal world, and not the messy, constrained, compromise-filled world that we actually live in. If you want to see what a pure libertarian society looks like, I give you: Somalia. The rest of us realize that we need some constraints on human nature to preserve law and order, and enforce contracts.

 

[Faiez]

Clearly you've never worked for a company that went bankrupt, or was engaged in questionable practices, or fired you.

This is where I have the conflict with you. I don't see it the way you do.

A businessman can loose money and not get anything for his work and then he can get this plus loose assets as well. On the other hand a salaried person can only loose a stable source of income, not the underlying income generating asset (his skills or ability to work). Where as a businessman can loose his ability to invest (when he looses money).

Yes, most capital holders earn labor income and investment income. They share the same labor income risks that non-investor laborers share, but they diversify their income stream with investment income. This diversification lowers their risk vs. the pure laborer. Entrepreneurship is just a hybrid form of investment and labor. The entrepreneur also does not lose his skills when his business fails, just like the accountant doesn't lose his skills when he is fired. But what about the difference between a worker who has unvested options in his company as part of his compensation vs. the entrepreneur? Your differentiation is not as clean as you present, because now you have a situation where both lose more than simply a salary when facing involuntary separation from their companies.

Here is how I see it. A business man uses his money and skills to make more money risking losing money as well. A worker uses only his skills to make money with no chance of loosing anything unexpectedly. Now I don't really know what unvested options are so.... But I'm thinking it's something like they get a reward that's only cash-able after what ever many years...So in this case was that not already clearly written on the contract? Wasn't the risk pre-calculated and fixed? Unlike in a business.

So a worker can only lose as is expected. He knows everything in advance, it's a contract. A businessman's loss is at times completely unexpected. He doesn't have a contract with the market or something.

@bold part : That's not really risk diversification...It's like trying to hedge an investment in a stock by investing more in the same stock...

Let me further elaborate. A worker's assets are his skills. A businessman's assets are his skills + his money. A worker risks getting fired. He wouldn't loose any of his assets. All he loses is a future contract for services. He still gets the rightful reward for services already rendered but now he will have to find another job. Whereas a businessman works without a guaranteed return for his work(no salary, although you might argue against it, but seriously salary from his own money? and even from that taxes are deducted), meaning he does not really get paid for his work. Plus he risks loosing assets (his investment money).

In an ideal world, yes. But I have never understood why Libertarians believe we live in an ideal world, and not the messy, constrained, compromise-filled world that we actually live in. If you want to see what a pure libertarian society looks like, I give you: Somalia. The rest of us realize that we need some constraints on human nature to preserve law and order, and enforce contracts.

With a democrat party in power, the country does not completely turn into a socialist state. Similarly with a libertarian party in power, it will only go in the libertarian direction, not turn into a complete wild west like the movies...

Also when I say libertarian, I mean a country where there still are atleast courts, a basic police force plus a basic defence force (and not one that costs USD700 billion a year with little/no accountability). Can't really say about currencies and central bank...May be there shouldn't even be a centralized currency(so government has no monetary control) but such a change would probably take decades to implement if you have a libertarian party in power right now.

 

[LeveragedBuyout]

This is where I have the conflict with you. I don't see it the way you do.

A businessman can loose money and not get anything for his work and then he can get this plus loose assets as well. On the other hand a salaried person can only loose a stable source of income, not the underlying income generating asset (his skills or ability to work). Where as a businessman can loose his ability to invest (when he looses money).

I see where the fissure is. You're talking about a business just starting up, before it has any cash flow. Yes, it can fail, and the entrepreneur will lose his investment. But after the business starts generating cash flow, that cash can be used to pay a salary, or secure financing to pay a salary, in which case, the investment in the business begins to yield a return (and diminish the possible losses to the entrepreneur). Remember that a failed business, if structured as a corporation (LLC or C-Corp) does not pass on its liabilities to the owner, so it's not possible to lose more than one's investment.

Otherwise, yes, entrepreneurship is risky. That's why success brings outsize returns.

Here is how I see it. A business man uses his money and skills to make more money risking losing money as well. A worker uses only his skills to make money with no chance of loosing anything unexpectedly. Now I don't really know what unvested options are so.... But I'm thinking it's something like they get a reward that's only cash-able after what ever many years...So in this case was that not already clearly written on the contract? Wasn't the risk pre-calculated and fixed? Unlike in a business.

Yes, it's usually a forced option purchase, structured so that separation before the exercise period causes the option to expire worthless. Now tell me, what is the difference between an equity contribution by an entrepreneur, and an equity contribution (through options) of an employee? In your mind, the employee loss of equity should be dismissed, but the owner loss of equity is devastating. Why?

So a worker can only lose as is expected. He knows everything in advance, it's a contract. A businessman's loss is at times completely unexpected. He doesn't have a contract with the market or something.

Why do employees have perfect visibility, but the one who controls the business has no visibility? I don't follow your logic.

@bold part : That's not really risk diversification...It's like trying to hedge an investment in a stock by investing more in the same stock...

While investing in the company one works for is not always advisable, it's still diversification. An IBM employee who buys IBM stock, and is then fired, can at least continue to derive the benefit of IBM's performance, even after separation. The danger comes in cases like Worldcom or Enron, but those situations present a danger to salaried employment as well. I also want to point out that any 401(k) investments, even if not in company stock, would be at risk in case of bankruptcy (of the company, of the fiduciary, of the broker, etc.) if the government did not insure these investments for fraud/bankruptcy, etc.--something to keep in mind for libertarians.

Let me further elaborate. A worker's assets are his skills. A businessman's assets are his skills + his money. A worker risks getting fired. He wouldn't loose any of his assets. All he loses is a future contract for services. He still gets the rightful reward for services already rendered but now he will have to find another job. Whereas a businessman works without a guaranteed return for his work(no salary, although you might argue against it, but seriously salary from his own money? and even from that taxes are deducted), meaning he does not really get paid for his work. Plus he risks loosing assets (his investment money).

Successful entrepreneurs know that the core rule is to pay yourself first. Also, why do you assume that the entrepreneur never earns back more than the principal? You are too fixated on the bankruptcy in the first year scenario. Companies can also fail after the principal is returned. At that point, the owner has all of the benefits of the salaries employee, plus all of the benefits of a capital holder. Indeed, the owner can structure payments to best take advantage of the tax system (as salary, as dividends, as capital gains, as loan repayments, etc.), which is a tremendous advantage over the salaried worker, who has no choice.

With a democrat party in power, the country does not completely turn into a socialist state. Similarly with a libertarian party in power, it will only go in the libertarian direction, not turn into a complete wild west like the movies...

Democrats in power have burdened us with the income tax and the economy-destroying welfare state, so it's hardly the moderate force you present. Your vision requires a libertarian party in power, which has never happened in US history. What prospects do you see for libertarian majorities in Congress, or a libertarian president?

Also when I say libertarian, I mean a country where there still are atleast courts, a basic police force plus a basic defence force (and not one that costs USD700 billion a year with little/no accountability). Can't really say about currencies and central bank...May be there shouldn't even be a centralized currency(so government has no monetary control) but such a change would probably take decades to implement if you have a libertarian party in power right now.

OK, now that we're talking compromise of pure ideological principals (which demand, essentially, anarchy), what prevents a little bit more compromise in order to achieve your core aims? The lines you've drawn are arbitrary. Libertarianism has a spectrum, just like any other political ideology. You've chosen minarchy, but libertarianism can be (and in practice, is) more accommodating than that.

 

[Faiez]

I see where the fissure is. You're talking about a business just starting up, before it has any cash flow. Yes, it can fail, and the entrepreneur will lose his investment. But after the business starts generating cash flow, that cash can be used to pay a salary, or secure financing to pay a salary, in which case, the investment in the business begins to yield a return (and diminish the possible losses to the entrepreneur). Remember that a failed business, if structured as a corporation (LLC or C-Corp) does not pass on its liabilities to the owner, so it's not possible to lose more than one's investment.

Otherwise, yes, entrepreneurship is risky. That's why success brings outsize returns.

Offcourse, but here's the thing, you LOOSE something. In a job you loose nothing except the job at the very most.

Yes, it's usually a forced option purchase, structured so that separation before the exercise period causes the option to expire worthless. Now tell me, what is the difference between an equity contribution by an entrepreneur, and an equity contribution (through options) of an employee? In your mind, the employee loss of equity should be dismissed, but the owner loss of equity is devastating. Why?

It's not a forced purchase. It's voluntary. No one's forcing the guy to sign on the contract. He does it voluntarily. If it's being signed under force, he can go to court.

Why do employees have perfect visibility, but the one who controls the business has no visibility? I don't follow your logic.

Perfect visibility over the outcome of his work. A worker provides services for money in a contract. A businessman has no binding contract with anyone to ensure he keeps making money or doesn't loose money.

While investing in the company one works for is not always advisable, it's still diversification. An IBM employee who buys IBM stock, and is then fired, can at least continue to derive the benefit of IBM's performance, even after separation. The danger comes in cases like Worldcom or Enron, but those situations present a danger to salaried employment as well. I also want to point out that any 401(k) investments, even if not in company stock, would be at risk in case of bankruptcy (of the company, of the fiduciary, of the broker, etc.) if the government did not insure these investments for fraud/bankruptcy, etc.--something to keep in mind for libertarians.

He's not a businessman. A businessman is someone who actively does a business and that's his source of income. Not some guy who owns some stock in a company. For a business man, the fact that he owns stake in his company is not risk diversified as you suggested in your original post that I responded to.

I don't know how a 401k works, but isn't the worker told of the risks of investing in 401(k) before hand ?

Successful entrepreneurs know that the core rule is to pay yourself first. Also, why do you assume that the entrepreneur never earns back more than the principal? You are too fixated on the bankruptcy in the first year scenario. Companies can also fail after the principal is returned. At that point, the owner has all of the benefits of the salaries employee, plus all of the benefits of a capital holder. Indeed, the owner can structure payments to best take advantage of the tax system (as salary, as dividends, as capital gains, as loan repayments, etc.), which is a tremendous advantage over the salaried worker, who has no choice.

Businessmen re-invest too. Also, he doesn't really have all the benefits of a salaried employee. He takes much much much much higher risks. He went to work with something already on his plate. The worker went to work with an empty plate. Now if they return with an empty plate it's not the same thing.

I didn't assume businesses don't recover the principle. I just pointed out that any capital gains are taxed, but should there be capital losses, there's no protection for that. Where as an employee losing job has safety nets that make sure he keeps living a decent lifestyle for atleast a while. In a way you could say that's what he was paying the income taxes for (in return for a safety net). But then what's the businessman paying capital gains tax for when he get's nothing of that sort (say a "bad business benefit" of 25% of the annual capital gain income he averaged in the last few years) as a safety net? Now you could argue that it's different because one guy is still rich and the other could starve. But the government taxed the crap out of both and blew away the money!

Democrats in power have burdened us with the income tax and the economy-destroying welfare state, so it's hardly the moderate force you present. Your vision requires a libertarian party in power, which has never happened in US history. What prospects do you see for libertarian majorities in Congress, or a libertarian president?

If I had lots of money or if I make lots of money ever, I'll make sure I fund them, that's for sure. So excellent prospects then .

OK, now that we're talking compromise of pure ideological principals (which demand, essentially, anarchy), what prevents a little bit more compromise in order to achieve your core aims? The lines you've drawn are arbitrary. Libertarianism has a spectrum, just like any other political ideology. You've chosen minarchy, but libertarianism can be (and in practice, is) more accommodating than that.

I don't know all the terms man...I know what hardcore libertarianism is....Although it sounds fair but it's kind of hard to picture. So perhaps a free market of a milton-friedman kind (what he used to talk of)...So if you have perhaps a libertarian party in power, but not absolute power. the country would slowly turn into a decent reasonably free market. So in short a government that does just 3 or 4 main things like providing a justice system, a decent police force and a decent army, all funded through very low involuntary taxes or by completely voluntary taxes. You may argue that no one would pay voluntary taxes, but that's not entirely true. For example in Pakistan, in Karachi, there is no state provided medical emergency ambulance service. So it all gets covered by charity organizations. And they run on charity (same as a voluntary tax) and pretty good too.

In short what I'm against is involuntary taxation of any kind and government interventions. So what I want is a government run like a charity organization. That's what I want, what ever it's called.

 

[FairAndUnbiased]

Faiez there is such a thing as statistical arbitrage, where you design a portfolio in such a way (with hundreds of different instruments being held for short amounts of time) that it can never lose money.

There is also exchange arbitrage where several currency conversions do not yield the same value at the end (for example convering from USD to Euros to Rubles to Yen to USD doesn't yield the same value of USD as the original).

There are actually multiple investment strategies where you can make risk free profit (arbitrage) which negates your entire point that entrepreneurship and investment is inherently risky. There is a mathematical definition of risk, and there are huge categories of investment activities that are mathematically risk-free.

 

[Daneshmand]

This is pretty much true in other fields as well. I would not be surprised if 80% of comments on this forum also comes from 20% of active members.

 

[rubyjackass]

The name Pareto law has a hint. The Pareto guy observed that income distribution follows Pareto distribution. As to why it fundamentally follows the law, I don't know. Probably no one explained definitively anything of that sort. But most human or for that matter biological choices are made according to Pareto distribution. For example, how does a foraging animal determines the next area it wants to search for food. This search follows Pareto distribution.

Pareto found the 80-20 rule just like Newton found F=ma. By experimentation. But there are ways to rationalize this pattern. One theory is that this form of foraging is the most efficient and so natural selection led to animals which do this sort of search to survive.

All other places where you see this distribution, like in income distribution, then probably are consequences of our choices made based on other such probability distributions.

 

[William Hung]

OK I've done a bit more pondering (but am still as puzzled as before). Here are some of my lingering thoughts:

- I was wrong to say that the capitalism VS. the other -ism debate does not matter if the 80/20 rule holds true. Reading the explanations and debate between @LeveragedBuyout and @Faiez makes me think that even if we can't change the wealth distribution, we can change how that distribution came about. That is, we may have to accept that the top 20% will always control 80% of the total wealth, but we can still question whether the top 20% deserved to be there, whether they got there through good merits/efforts or through corruption, nepotism, tyranny, etc. So we can never change the 80-20 wealth distribution, but we can change how the top 20% gets there (or maybe not).

- If the 80-20 rule holds true, then I would need to disagree with @Edison Chen's last comment that we should find a perfect distribution mechanism. The wealth distribution will always be around 80-20 no matter what we do.

- The explanations given by @Gauss, Ed, LeveragedBuyout sounds perfectly correct in rationalizing our 80-20 wealth distribution. But I still have an intuition/feeling that it is some other more fundamental principles/laws (maybe the laws of physics?) that give rise to this distribution. My thinking for this goes as follow:


1. We can observe this 80-20 distribution in lots of fields as mentioned by @Daneshmand and @rubyjackass.

2. We should agree that these 80-20 distributions observed throughout the universe are not simply a big coincident. They must have came about through some common cause. To identify this common cause, we obviously must try to find a common factor/s that can be identified in all of these 80-20 distributions.

3. In terms of wealth distribution, we could perhaps attribute this 80-20 distribution to the political system (including tax system, labor laws, etc.) of each countries. But we cannot consider these political systems as the common factor since each country have different political systems, yet still produced the approximate 80-20 distribution. The political system of contemporary USA is not the same as 20th century Italy where Pareto first observed its 80-20 wealth distribution.

4. We can perhaps try to attribute the "common factor" to human traits. As LeveragedBuyout and Gauss has explained, people differ in intelligence, ability, drive, etc. and this will give rise to the 80-20 wealth distribution as observed throughout history. Rubyjackass brings in natural selection to further explain these human traits, and we can perhaps even extend this explanation to other biological life forms. These explanations sound very plausible (and common sensical) but there is one difficulty I have with these explanations: not all systems that produce the 80-20 distribution contains biological life forms.

5. Consider the craters on the moon. Supposedly, we could also observe the 80-20 distribution if we graph the number of craters and it's frequency according to craters sizes. But how these moon craters came about did not involve any biological life forms. And there are lots of other examples where the 80-20 distribution can be observed where biological life forms are not involved at all. So natural selection cannot explain these examples. Human traits can perhaps help us explain/rationalize our 80/20 wealth distribution, but these traits are not the common factor behind all 80-20 distributions observed throughout our universe.

Conclusion 1: We can perhaps conclude that every 80-20 distributions that we have observed has their own different causes. There exist no common cause or factors among them. 80-20 wealth distribution are causes by human traits, 80-20 moon craters distributions are perhaps caused by the laws of physics, 80-20 distribution of animal foraging behaviour are caused by natural selection, and so on. The common 80-20 distributions that arises from each different causes are just a BIG coincident. But I don't like this idea of dismissing these observations as coincidence. My gut feelings tells me that there is a common cause or common factor.

Conclusion 2: I'm more inclined to conclude that there is indeed a common cause, and perhaps this common cause can be explained by the law of physics (?). If this is correct, then it means that the global wealth distribution and economy are determined by the laws of physics? (is this what @FairAndUnbiased was hinting at earlier?)

*stillpuzzled*

 

[rubyjackass]

- I was wrong to say that the capitalism VS. the other -ism debate does not matter if the 80/20 rule holds true. Reading the explanations and debate between @LeveragedBuyout and @Faiez makes me think that even if we can't change the wealth distribution, we can change how that distribution came about. That is, we may have to accept that the top 20% will always control 80% of the total wealth, but we can still question whether the top 20% deserved to be there, whether they got there through good merits/efforts or through corruption, nepotism, tyranny, etc. So we can never change the 80-20 wealth distribution, but we can change how the top 20% gets there (or maybe not).

The 80-20 rule was a very old observation. I don't know of any recent confirmation of this principle. So you should not read too much into the rule today. It only helps to get an idea of economic inequality.

There are ways to mitigate this inequality. Progressive taxation is a well accepted weak measure. I would suggest weakening property rights(basically saying your kin cannot inherit your property or you cannot write your property to someone) as a radical measure. There are many rich aholes who made it big because of no apparent skill or benefit to society.

- If the 80-20 rule holds true, then I would need to disagree with @Edison Chen's last comment that we should find a perfect distribution mechanism. The wealth distribution will always be around 80-20 no matter what we do.

Inaccurate. 80-20 was noticed some centuries ago and it was just carried on as an interesting ideatic line.

2. We should agree that these 80-20 distributions observed throughout the universe are not simply a big coincident. They must have came about through some common cause. To identify this common cause, we obviously must try to find a common factor/s that can be identified in all of these 80-20 distributions.

There is research going on in this area. As I said, my understanding of the research I know is that this distribution's success has to do with efficiency, efficiency of search in general. We should probably look for some real badass researchers in PDF to come and answer these questions.

Conclusion 1: We can perhaps conclude that every 80-20 distributions that we have observed has their own different causes. There exist no common cause or factors among them. 80-20 wealth distribution are causes by human traits, 80-20 moon craters distributions are perhaps caused by the laws of physics, 80-20 distribution of animal foraging behaviour are caused by natural selection, and so on. The common 80-20 distributions that arises from each different causes are just a BIG coincident. But I don't like this idea of dismissing these observations as coincidence. My gut feelings tells me that there is a common cause or common factor.

At least with regards to human traits, I have this to say. Human traits are actually a result of natural selection. In the sense that all humans with traits that caused inefficiencies got wiped out.

Conclusion 2: I'm more inclined to conclude that there is indeed a common cause, and perhaps this common cause can be explained by the law of physics (?). If this is correct, then it means that the global wealth distribution and economy are determined by the laws of physics? (is this what @FairAndUnbiased was hinting at earlier?)

*stillpuzzled*

Probably efficiency. Most physical phenomenon like radioactive decay follow other distributions - Normal, Poisson. Pareto distribution is starkly observed mostly in biology and economics.

 

[FairAndUnbiased]

It all comes from statistical thermodynamics. There's no difference between 2 particles exchanging conserved energy and 2 people exchanging conserved money.

 

[Faiez]

It all comes from statistical thermodynamics. There's no difference between 2 particles exchanging conserved energy and 2 people exchanging conserved money.

money is not conserved...