Have you ever wondered why a few people end up owning and controlling the vast majority of a society’s wealth, or why aristocracies inevitably develop in practically every culture, past or present? Have you pondered the egregious wealth inequality in the US where the top 1% owns the wealth equivalent of the bottom 95% combined? Some years ago, I set out to investigate how capitalism really works using a totally clean slate and using new computer programming methods. Over several months during the spring of 2003, I constructed a model economy using statistically equal entities, and I achieved results far beyond my initial expectations. It turns out that huge levels of wealth inequality are built into capitalism-even among statistically equal people. Capitalism takes the wealth generated by the society and then re-distributes it to a tiny minority.
My model economy programs use stochastic (i.e., equal chance) methods with economic agents who own equal amounts of wealth initially. Economic agents follow the following simple paradigm:
Using just the three points above, a decent approximation can be made of what an actual capitalist wealth distribution will actually look like. Through trial and error, and by reconstructing the process that would tend to maximize individual agent relative wealth, I found that an investment hierarchy in addition to the above points generates correct wealth distributions. The “investment hierarchy” that I am speaking of represents the employer to employee relationship (especially corporate management): in the model economy as in real capitalism, employer investment money becomes employee labor income. In turn, the next lower tier employee becomes the employer and source of labor income to the tier of employees below him, and so on and so forth. After the hierarchy makes their investments, monetary exchanges take place for goods and services, and then return on investments filters back up through the hierarchy. This methodology produces astoundingly accurate results. Not only can one accurately predict personal wealth using this algorithm, but it also produces correct stock market capitalization (i.e., corporate wealth) distributions. The power of using this method comes from its predictive power. For example, one may now answer the following question: What will be the long term distribution of wealth of any large group of people participating in capitalism without taking taxes into consideration?
- Agents make investments.
- Agents make monetary exchanges.
- Agents receive returns on investment.
Answer: According to the model,
If you keep track of such things, then you may have noticed that the above computer generated predictions match the current US wealth distribution almost exactly. However, I also said that the predictions don’t take taxes into consideration. It turns out that taxes in the US have no re-distributive effect whatsoever. Our tax system guarantees that wealth will be as concentrated as possible, and that after taxes that wealth will still be as concentrated as possible.
- The top 1% will own 35% of the wealth
- The top 5% will own 64% of the wealth
- The top 10% will own 75% of the wealth
- The top 20% will own 84% of the wealth
- The bottom 60% will own 5% of the wealth
- The bottom 40% will own .013% of the wealth
Let me make a few more observations about capitalism as illuminated by the model economy:
- The investment process itself causes wealth inequality for the entire population. Moshe Levy of the Jerusalem School of Business proved that success in investing was independent of investment ability for the wealthiest people. My paradigm generalizes this idea for the whole economy because it takes trade into account, and because it shows that all people are investors.
- If people are equal in every respect, and if they can make even the most basic decisions to increase their wealth, then a wealth distribution such as the one I have described has to develop. This distribution appears in every real free market capitalist economy
- All members of an economy are investors. Even though people at the bottom get most of their money through labor income, they still have to invest at the same rate as the wealthiest people if they are going to maintain their relative wealth (i.e., their piece of the pie). An example of how an ordinary person invests could be: a person pays someone to remodel their kitchen, and then their house is sold for a profit or loss when taking the original house cost plus the remodeling cost into account.
- The neo liberal idea that if the trade rate increases, then the wealth inequality decreases is true, but it doesn't work well in a real economy. If there were no hierarchy (bosses and workers), then neo liberalism would work (but the environment would be damaged since increasing the investment rate increases consumption proportionally). The hierarchy's effect on increasing wealth inequality far outweighs trade's ability to decrease wealth inequality.
- The vast majority of wealth inequality is caused by the hierarchy (bosses and workers). However, it would be impractical to remove the intermediary agents between investors and producers because economies have large numbers of people, and single people would have great difficulty making exchanges with tens of thousands of people.
- Progressive taxation is the best way to reduce wealth inequality in a free market capitalist system. The easiest way to do this is to tax the income of the wealthy, but a wealth tax would work too. Taxation though, has to redistribute wealth, or it won't work.
There is much more to all of this, but I have run out of time tonight to explain it all. Thanks for taking the time to read this article.
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