Patterico's Pontifications


Economics Lesson

Filed under: Economics — Patterico @ 9:38 am

This is for everyone out there who is distressed at the disparities in wealth that they see in our society.

Let’s pretend that I create a society in which the wealthiest 17% of the population has five times the income of the bottom 17% — and 25 times the accumulated wealth of the bottom 17%.

Does this society sound “fair” to you? Please answer before you read further.

Extended Entry

I have just described a society in which every single person is treated exactly the same in terms of income, raises, and savings. The example comes courtesy of Thomas Sowell, modern society’s preeminent explicator of basic economic principles.

In Sowell’s imaginary society, each worker begins his career at age 20, and earns $10,000 per year. Each decade he receives a $10,000 raise, so that in his 30’s he earns $20,000 per year, etc. (We assume also that each person’s subsistence level is $5000 per year, and that each is similarly situated in terms of his ability to save.)

Each person saves 10% of whatever he earns above subsistence level (he uses the rest of his “profit” to increase his standard of living, like most people do).

Assuming everybody does similar work, with similar hours, etc., “inequities” soon begin to appear between younger and older folks. This is because the older you get, the more you earn and save.

In our hypothetical perfectly equitable society, at age 20, your annual income is $10,000. Your annual savings are $500 (10% of $5000 — your profit after subtracting the $5000 you need to live on). Your lifetime savings are zip.

At age 30, your annual income is $20,000 (after the $10,000 raise) — double that of the lowest wage-earners. Your lifetime savings are $5000 (after 10 years of saving $500 per year). Your new annual saving rate is $1500 per year (10% of $15,000 — your profit after subtracting the $5000 for basic subsistence).

At age 60 (to skip ahead), your annual income is $50,000 — five times that of the lowest wage-earners. Your annual savings are $4500. Your lifetime savings are $80,000 — sixteen times that of someone at age 30.

Ultimately, the end result of the scenario is that the wealthiest 17% of the population will have five times the income of the bottom 17% — and 25 times the accumulated wealth of the bottom 17%. And their standard of living will be visibly higher as well, since their profits after savings will be buying them nicer houses, cars, etc.

How terribly unfair!

Only, of course, it’s not. It is a simple economic fact that people’s income and savings naturally grow over time. Even in a perfectly equitable society, in which everyone is treated exactly the same, disparities appear because some people have been working and saving all their life, and others haven’t.

Ironically, one can easily imagine these statistics causing a general outcry for “solutions” to the “problem” of “inequity” — in a completely equitable society.

And what would that solution be? You could eliminate raises entirely — so that one who has accumulated a lifetime of skill is rewarded no greater than a beginning worker. (Is that “equitable”?) That would eliminate income disparities — but what about wealth disparities? Are we going to outlaw savings?

The bottom line is this: as long as you allow raises to compensate for experience, and you allow people to save, you are going to have income and wealth disparities.

This is something to keep in mind the next time that you see a leftist group engaging in hand-wringing over income and wealth disparities in this country.

10 Responses to “Economics Lesson”

  1. We must immediately outlaw money and the right to own personal property… that will solve everything.

    Watcher (a1e7b4)

  2. There are legitimate complaints about wealth disparities: Namely, the massive transfer from shareholders of public companies to senior management.

    Years ago, the compensation ratio between the lowest paid clerk and the CEO/CFO was 20 or 30 to 1. Over the past decade — thanks to unexpensed stock options — the number has skyrocketed to 300 to 1.

    I do not know a legitimate critic who suggests that there shouldn’t be a wealth disparity based upon the value of your work product. The guy who creates a cure for cancer will earn more than the guy who mows your lawn.

    But the “creative accounting process” of not expensing options — a definite cost (How is it that options are deducted on corporate tax returns?), creates a situation where corporate profits are made to look artificially higher, incentivized insiders to focus on the short term (i.e., mnaximizing ST share price right after their options vest), and failed to provide investors accurate information about the profitibility and return on capital of public corporations.

    Personally, I’d like to see that issue addressed — as opposed to the creation and desstruction of some silly communist era “straw man” . . .

    Barry Ritholtz (306231)

  3. The economic problem in the world is what to do with seemingly “economically unneeded” people. All this “fairness” talk is just ignoring the Moose-on-the-table. Talented people do things. The fight is over how talented people should be fettered and harnessed. Historically the economic/cultural heavens have been where talent was “controlled” minimally. By clear rules that were seen to apply to most. Lets get an argument started over how much more advanced Europe would be if the USA had never become the world-economic-power.

    Ju (d66f3b)

  4. Barry,

    Given that we are constantly beaten over the head with statistics regarding income and wealth disparities, I don’t think it’s a straw man argument at all.

    My point is not that America is perfect. My point is simple: a significant portion of the “disparity” that the public sees reflected in income/wealth disparity statistics is, in fact, an unavoidable consequence of the capitalist system. A lifetime of working *should* create disparities between the old and the young. If we are going to allow people to earn raises and save money, we need to back out the effect of age differences on income disparities. Then these statistics that are trotted out by Democrats in support of their class warfare arguments would lose a lot of their punch.

    Let me thank Thomas Sowell again; the entire post is constructed on an example of his.

    Patterico (f7b3e5)

  5. Amazing, man! I had no idea Bill Gates was so old.

    Xboy (340faa)

  6. Another strawman bites the dust! Yes, you read that right: I asserted that *all* disparities resulted from age. I guess you showed me.

    By the way, I know that the fact that Bill Gates has a fortune hurts you — but could you explain how?

    Patterico (b01694)

  7. This is a bit OT, but here goes.

    The thing that bothers me is that there are all these people out there complaining about how “horrible” business is for one reason or another – but you never hear a peep out of them about government.

    Last time I checked Microsoft didn’t put put people in the electric chair, beat up black motorists, or drop bombs on Iraq (to use examples that resonate with those same people who are usually found complaining about business).

    Jim (e1f1bf)

  8. Microsoft doesn’t just hurt people, it hurts business.

    How much are you paying for your people having to waste time dealing with viruses and spam being sent through hijacked computers, even if you don’t use Windows at your office?

    Who’s responsible for that?

    If you don’t say “Microsoft”, you’re deluding yourself.

    President Leechman (92803a)

  9. Carnival of the Capitalists
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  10. Josh Cohen brings you
    The Carnival of the Capitalists — postings from all over the market-positive blogosphere. I particularly liked this posting by Patterico….

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