Wednesday, March 28, 2018

Vox Popoli: The mystery of US inequality (which is plain to see if one looks)

Ugo Bardi finds it difficult to explain the post-1960 rise in US income inequality in his very interesting book The Seneca Effect, which seeks to apply some of the concepts that NN Taleb has developed while investigating the science of collapse.
Obviously, the larger the Gini coefficient, the larger the income inequality. The case of perfect equality has Gini = 0 since the area of A is equal to zero. The opposite case would be when only one person owns all the wealth while all the others own nothing. This condition would generate a Gini coefficient equal to 1. Both conditions are obviously improbable and coefficients measured for different countries range, typically, from 0.2 to 0.7 (sometimes given in percentiles, that is from 20 to 70). Some countries are less egalitarian than others: for instance, South-American countries have normally high Gini coefficients, with Brazil perhaps at the top with around 0.6. On the opposite side, European countries are rather egalitarian, with income coefficients in the range from 0.2 to 0.4, especially low in Scandinavian countries. About the United States, it had seen a trend toward lower inequality that started in the ninetieth century and that accelerated after the end of the second world war, thus making the US trend similar to that of most European countries. But the trend changed direction in the 1960s-1970s, to arrive today at values of the Gini coefficient between 0.4 and 0.5, typical of South American countries. This phenomenon is part of the series of economic changes in the US economy that was termed “The Great U-Turn” when it was noted for the first time by Bluestone and Harrison.

There is no general agreement on what happened to the US society that caused such a change in the trend of the income distribution. What we know is that a lot of money flew away from the pockets of middle-class people to end up it in the pockets of the wealthy. As you may imagine, we have here another one of those problems where the large number of explanations provided is an indication that nobody really knows how to answer the question. For instance, there is no lack of conspiracy theories that propose that the rich formed a secret cabal where their leaders collected in a smoke-filled room to devise a plan to steal from the poor and give to the rich. Recently, I proposed that the “U-Turn” may be related to the peak in oil production that took place in the US in 1970. At that moment, the US started a rapid increase in the imports of crude oil from overseas. The result was that the money that the Americans spent on foreign oil returned as investments in the US financial system, but from there it never found its way to the pockets of middle-class people. But I am the first to say that it is just a hypothesis.

Actually, something else happened right between the 1960s and 1970s, in 1965, as a matter of fact, that just might have had a little something to do with the lower-income classes suddenly facing more competition and more pressure on their wages, and the higher-income classes benefiting from larger corporate profits.

I refer, of course, to the 1965 Immigration Act that has resulted in 130 million new !Americans! as well as 45 straight years of lower average wages since 1973.

And there is one other obvious hypothesis that Bardi fails to note, which is a little ironic in light of what he writes about the specific way in which the very rich are different than you and me,
which is how that they go about making money and building wealth in a more holistic and heavily networked manner.

The rich, apparently, can even defy entropy by following a wealth distribution that ignores its effects. But what exactly makes a person rich or poor? An interesting feature of the thermodynamic distribution model of incomes is that being rich or poor is purely casual; the rock-paper-scissors is not a game of skill (nor is the second principle of thermodynamics!). Certainly, in real life, skill and grit count in one's career, but it is also true that most rich people are the offspring or rich families. As you may imagine, the idea that wealth is inherited rather than earned is not popular with the rich but, for some reason, they seem to be the ones who are most active in dodging and opposing inheritance laws.

Still, that doesn't explain why the rich seem to live in a world of their own in which thermodynamics laws don't seem to apply. Perhaps we can find an answer noting that power-laws tend to appear when we look at the evolution of highly networked systems, that is, where each node is connected to several other nodes. The Boltzmann-Gibbs statistics may be seen to apply to a “fully connected” network in the sense that each molecule can interact with any other molecule. But it is also true that, at any given moment, a molecule interacts with no other molecule or, at best, with just one in the kind of interaction that, in physics, is called “pairwise.” In a gas, molecules bump into each other and then they leave after having exchanged some kinetic energy; these pairwise interactions don't affect other molecules and so don't generate feedback effects. And, as it is well-known, there do not exist phase transitions in the gas phase; only solids (and, rarely, liquids) show phase transitions as the result of feedback effects Something similar holds for the kind of economic interactions that most of us are involved with: we get our salary or our income from an employer and we spend it buying things in stores, and we pay our taxes to the government, too. These are, mostly, pairwise interactions, just like molecules in a gas and it is not surprising that the resulting distribution is the same. The rich, apparently, are much more networked than the poor and their many connections make them able to find and exploit many more opportunities for making money than us, mere middle-class people. So, they don't really play the Boltzmann game, but something totally different....

Today, salaried people engaged mostly in pairwise economic transactions may have become much more common. So, it may be that over time there has been a sort of financial phase transition where some money “sublimated” from the rich to move to the poor, an interpretation that is consistent with the trend for lower inequality that has been the rule during the past century or so. As times change and the trend is reversed, the rich may regain their former 100% of the distribution, leaving the poor totally moneyless; maybe as a result of the “negative interest rates” that seem to be fashionable today. But that, for the time being, is destined to remain pure speculation.

It is said that Scott Fitzgerald said, once, “The rich are different from you and me” or “The rich are different from us.” To which Ernest Hemingway replied: “Yes, they have more money." But, maybe, Fitzgerald had hit on something that only much later the physicist Yakovenko would prove: the difference between the rich and the poor is not just the amount of money they have. It is in how they are networked.

If only we could identify a highly networked group of people, concentrated primarily on the financial sector, who were not particularly influential in the United States before the 1960s, we might be able to understand who were the primary benefits of this massive shift in income inequality as well as how they took advantage of it. But since it is clear that no such group of people exists, this leads me to conclude that Signor Bardi is most likely correct with regards to his hypothesis about the socio-economic effects of the rapid increase in the imports of crude oil from overseas.

Fortunately, since the problem of excess oil imports has already been successfully addressed by increased domestic oil production and a concomitant reduction in US reliance on foreign oil, we can be confident that this post-1960s shift in the Gini coefficient will be corrected any day now and US income inequality will shift back to traditional European standards rather than the third world standard it has more recently come to resemble.