The 1 percent: How lucky they are

  • Article by: GREG BREINING
  • Updated: October 29, 2011 - 3:31 PM

The top 1 percent of Americans control about 40 percent of the nation's wealth.

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A demonstrator affiliated with the Occupy Wall Street carries a sign during a rally in New York's Times Square, Saturday, Oct. 15, 2011. Thousands of demonstrators protesting corporate greed filled Times Square on Saturday night, mixing with gawkers, Broadway showgoers, tourists and police to create a chaotic scene in the midst of Manhattan.

Photo: Mary Altaffer, Associated Press - Ap

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As a stagnant economy and the Occupy Wall Street protests ignite debate over the disparity of wealth in America, a little noticed economic study provides mathematical support for a radical idea. The rich get richer and the poor get poorer. You knew that. But you may not have known that according to a mathematical model developed at the University of Minnesota, the fabulously rich get as rich as they do by chance alone. In a capitalist society, extreme concentration of wealth does not arise from extreme differences in work ethic, skills, investment smarts or other virtues. Nor does it come from connections, cronyism or crookedness. Well, it does, but only some. Mostly, extreme wealth comes from luck. In a laissez faire economy, within a few generations, a handful of players walk away with all the marbles. Because they're lucky.

The policy implications should be alarming, especially if you're a Paul Ryan conservative or Ron Paul libertarian who has been saying that economic liberty gives everyone a chance to grab the golden ring. It's a vanishingly small chance. Indeed, if the model is accurate, the inevitable outcome of unfettered capitalism is oligarchy.

"That's the conclusion I came to, too," says Joseph Fargione, lead author of the paper, published this summer in the peer-reviewed journal PLoS ONE. "I was quite surprised by that."

Fargione first became intrigued by this question not as an economist, but as an ecologist. Fargione is lead scientist for the Nature Conservancy's North America conservation region and an adjunct professor of ecology, evolution and behavior in the University of Minnesota's College of Biological Sciences. Fargione noticed "interesting mathematical parallels" between exponential increases in populations and wealth accumulation. "It is something that ecologists think a lot about," he says.

The link between ecology and economics is not as far-fetched as it might sound. Ecologists had long thought that environmental factors and the characteristics of species would determine the evolutionary outcome of an ecosystem (just as many people insist that talent, hard work, and good decisions determine wealth). Put the same species together under the same conditions, the thinking went, and you'd get a similar result -- again and again.

But in the 1980s, James Drake, an ecologist at the University of Tennessee, repeatedly assembled "microecosystems" in five-gallon aquariums. He found he could add the same pond species in the same numbers under identical conditions -- and get a different result each time. Different species would gain ascendency and dominate the ecosystem -- as if by chance alone.

The wealth project took shape as Fargione read Kevin Phillips' "Wealth and Democracy: A Political History of the American Rich." As Phillips notes, Alexis de Tocqueville in 1837 warned the young American republic that its industrial class, "one of the harshest that ever existed," could create "permanent inequality of conditions and aristocracy." And so it did. Despite the interruptions of the Populist and Progressive eras and the New Deal, writes Phillips, by 2000 "the United States was not only the world's wealthiest nation and leading economic power, but also the Western industrial nation with the greatest percentage of the world's rich and greatest gap between rich and poor."

Fargione discovered that other mathematical models of wealth have failed to account fully for its concentration. Some economists blamed wealth concentration on political factors such as cronyism, or on differences in the sharpness of investors.

"What would you expect would happen on its own without a lot of intervention for redistribution of wealth?" Fargione wondered.

He began his research with a simple question: Can chance alone account for wealth concentration?

Fargione focused on entrepreneurs (who make up one in nine Americans) because, contrary to all advice to diversify portfolios, they typically plow their earnings back into their businesses. "Twenty years ago, Bill Gates didn't say, 'Well, I made some money -- I think I'm going to diversify my investment.'" The all-in strategy is risky, but when it works it leads to rapid accumulation of wealth.

He assumed that all entrepreneurs began with equal wealth. Returns varied, solely by chance. (Past performance is not an indicator of future success -- you've heard that before.) Earnings were reinvested. And for the purposes of the study, the investors seamlessly passed their wealth on to heirs. Says Fargione, "I started out with an Excel spreadsheet and just did some simulations that ran out over time."

Winner take all

I'll spare you the calculus, but according to Fargione's model, by the "inexorable effect of chance," and chance alone, "a small proportion of entrepreneurs come to possess essentially all of the wealth. ... The concentration of wealth occurs merely because some individuals are lucky by randomly receiving a series of high growth rates, and once they are ahead with exponentially growing capital, they tend to stay ahead."

According to Fargione, greater variation in rates of return hastened the concentration of wealth. Inequality grows with time. Wealth concentration continues despite periods of recession and depression. And splitting estates among heirs does not appreciably slow concentration.

In the real world, of course, some people are more skilled at making money than others. And business owners who are making a high rate of return, by operating highly successful companies, tend to continue earning high rates of return. And the rich have connections and other means to increase their wealth that most folks lack. "Those other factors would exacerbate the underlying pattern," says Fargione.

That underlying pattern is the inexorable concentration of wealth and the inevitable result -- winner takes all. Says Fargione, "If you play long enough, someone will end up with all the money."

Indeed, that is what has been happening in the United States, where the top 1 percent owns about 40 percent of total wealth.

As Ian Dew-Becker of Harvard University and Robert Gordon of Northwestern University have shown, between 1972 and 2001, the wage and salary income of Americans at the 90th percentile of income distribution climbed 34 percent. Income at the 99th percentile increased 87 percent; at the 99.9th percentile, 181 percent, and at the 99.99th percentile, 497 percent. Economists have paid "too little attention to the sources of increased skewness at the very top, within the top 1 percent of the income distribution," they write.

It's an entirely different story among the lower 90 percent. According to U.S. census figures released this fall, an additional 2.6 million Americans slipped below the poverty line last year. The 15.1 percent in poverty was the highest level since 1993. Among the middle class, median household incomes fell last year to levels last seen in 1996.

What would it take to arrest the growing divide between rich and poor? Not much, says Fargione. A tax on large inherited fortunes -- a "death tax" in Republican parlance -- aimed at the very wealthiest would interrupt the cycle of wealth concentration. (The current estate tax of 35 percent exempts the first $5 million in assets.) The estate tax has been a favorite target of Republicans and in fact was suspended in 2010.

Inevitable plutocracy

The greatest potential impact of Fargione's model is on our attitude toward accumulated wealth.

For if you are to believe Fargione's model, the result of Republicans' infatuation with conservative economics and laissez faire libertarianism is inevitable and permanent plutocracy.

That is intolerable for several reasons. Great disparity of wealth -- "the development of a race of the idle rich," in Winston Churchill's words -- violates our sense of justice and breeds social instability. U.S. Supreme Court Justice Louis Brandeis observed, "We can either have democracy in this country or we can have great wealth concentrated in the hands of a few, but we cannot have both."

Inequality may also be bad business in the long run. According to economists Andrew G. Berg and Jonathan D. Ostry of the International Monetary Fund, "In fact equality appears to be an important ingredient in promoting and sustaining growth. The difference between countries that can sustain rapid growth for many years or even decades and the many others that see growth spurts fade quickly may be the level of inequality."

But perhaps the greatest conceptual contribution of Fargione's model is that it relieves wealth of much of its moral baggage. Extreme wealth is not a reward for virtue. Nor is it the ill-gotten gains of collusion. It is the inexorable outcome of dumb luck, the giant cardboard check of a national lotto.

As beneficiaries of a system that paid them way out of proportion to any effort or virtue of their own, the superrich are entitled to some of their wealth, but not all.

They should give a lot of it back.

Greg Breining writes about science, nature and travel. He is the author of "Paddle North: Canoeing the Boundary Waters-Quetico Wilderness" and "Wild Shore: Exploring Lake Superior by Kayak."

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