The Cost of a Boom

As I follow up to my post on Peak Load Engineering, I thought it would be fitting to explore an element of a popular topic that conveniently seems to be left out of the national debate.

As of January 1, 2010 (I’ll explain why I use that date later, the unemployment rate in America stood at 9.7%, meaning 14.8 million Americans were officially out of work. (If you are unfamiliar with how unemployment is calculated and what terms like Labor Force Participation Rate mean, then this primer is highly recommended before you continue.)

Meanwhile, the Baby Boom Generation has continued to move their way through the “labor pipeline”. The 2010 Census revealed that while total US Population Grew 9.7% from 2000 to 2010, the 45-64 Age Cohort grew by an astonishing 31.5%. Not coincidentally, in 2010 the 45-64 Age Cohort perfectly aligned with the Baby Boom Generation, born in the years 1946-64. (The linked paper has some other interesting statistics on Generation X and Millennial’s population growth).

The question that immediately comes to my mind, is what real effect is the Baby Boom Generation having on the job market? We know there are a lot of them. And we know they are more likely to work later into their lives as previous generations. But what is the real effect? Thankfully, it’s a fairly easy calculation to make, and that’s what I’ll walk you through here.

To perform this analysis, we need to do three things:

  1. Figure out how many more of them there are as a result of their parents’ increased… um… fertility.
  2. Figure out exactly to what degree they are increasingly participating in the labor force.
  3. Figure out if their participation in the labor force is translating to more or less jobs. We expect the 45-64 Cohort to always have lower unemployment than younger generations strictly due to their increased experience and networks. Along with changes in population and labor force participation, has this changed at all?

So here we go…

Effects of Increased Population on Job Market

This is actually the most difficult of the factors to calculate, because it requires us making an assumption on what the Baby Boom Cohort’s population would be had we not seen the huge temporary spike in fertility rates that completely went against the clear downward trend. You remember this graph:

US Fertility Rates

The trend would seem to indicate the trend would have led us to fertility rates around 80 births per 1,000 women aged 15-44 around 1940 and around 70 per around 1970. Because I don’t get paid to do this research (hey, anyone want to pay me?) – I decided to NOT go through the entire practice of replacing actual birth rates with trended average rates. Instead, I took a loo at birth rates per 1,000 of total population (a different metric and saw) immediately before and immediately after the baby boom years of 1946-64, rates tended to be around 20 births per 1,000 of population, whereas they tended to be around 25 per during the baby boom years.

So instead of the complicated, more scientific (and more accurate) approach, I decided to simply cut the population of the Cohort by 20%. In all of these calculations, I divided the Baby Boomers into the 45-54 and 55-64 age brackets and used the corresponding statistics for those groups. I find this important because it is typical in our culture to work into our mid 50’s, but working in our late 50’s and mid 60’s is a relatively new development (undoubtedly promoted by the continually increasing Social Security retirement age).

Applying the new population against the actual labor force participation and unemployment rates in 2010, we the following results (I used January 2010 data for all of these figures):

Figures in thousands.

Basically, had fertility rates been 20% lower from 1946-64, we’d have 10.9 million fewer Baby Boomers holding jobs, all else equal.

Effects of Increased Labor Force Participation of Baby Boomers on Job Market

I’ve stated before that we’ve seen a cultural shift in America for people to work longer into their lives. Because I’m not just pulling this stuff out of thin air, I present this graph:

Labor Force Participation Rate Among Age Groups, 1948-2011

As you can see, there is a decidedly upward trend in labor force participation amongst older cohorts since 1991, when Boomers started to enter the 45-64 Cohort. Interestingly, we’ve seen labor force participation level off amongst the 45-54 cohort as the tail end of the Baby Boom Generation has entered the cohort. It will be interesting to see what happens as Generation X moves into this cohort.

To normalize Labor Force Participation Rate in this study, I looked at the Labor Force Participation Rate of the 45-54 and 55-64 cohorts in the 20-years immediately preceding the Baby Boom generation entering it in 1991. I applied the average Labor Force Participation rate of the respective cohorts from 1970-90 to the actual population and unemployment rates of those cohorts. The results:

Figures in thousands.

We find that, all else equal, the increased Labor Force Participation of the Baby Boom Generation results in 5.4 million more Baby Boomers holding jobs.

Effects of Unemployment Rate Variances on Job Market

This last component attempts to look at whether employer preferences have changed to favor either younger or older workers. As stated early, we expect older cohorts to have a lower unemployment rate than the national average, as older cohorts tend to be more experienced and have the benefit of having established professional networks over the years. Sure enough, with very few exceptions, the unemployment rate of older cohorts is always lower than the national average.

That fact alone, however, does not tell us whether or not employers are trending towards younger workers, so I compared the delta of the older cohorts u-rate versus the national average versus the same delta for the 20-years proceeding the Baby Boomers entering into the 45-64 cohort. I applied the 1970-90 delta to the 2010 unemployment rate to calculate the effect on the job market with a normalized unemployment rate. The results:

Figures in thousands.

What I found is that employers actually are favoring younger employees when compared to the 20-year generation prior to when the Baby Boomers entered the 45-64 cohort, but only minimally. As a result, there are 397,000 less Baby Boomers holding jobs than if we normalize the u-rate delta.

Normalizing All Three Factors

Now what if we normalize all three factors? We assume fertility rates were 20% lower during the Baby Boom, we apply the 1970-90 average Labor Force Participation Rate, and we apply the 1970-90 u-rate delta? Here are the results (note, they aren’t simply the sum of the three factors individually analyzed above, because of the changing population against the second two variable changes).

Figures in thousands.

14.9 million jobs are currently held by Baby Boomers that otherwise wouldn’t be if we change those three variables, which is eerily similar to the 14.8 million who were out of work in January 2010.

In the context of the Peak Load Engineering discussion from last week, is there some blame to be placed on post-WWII fertility rates for our current economic situation? I would argue yes, though I use the word “blame” in a non-malicious way. The real blame needs to go to our leaders who failed to foresee and plan for this problem. (Sorry, I don’t have any blame to put onto George W. Bush or Barrack Obama, which might disappoint about 60-80% of Americans)

I would also be quite remiss to not point out some obvious things, such as that much of the economic growth we’ve experienced to date needs to be credited to the work and innovations of the Baby Boom generation. Not to mention the fact that many of us (myself included) would not be alive if not for the Baby Boom Generation (we can’t be born if our parents never are).

As usual, I don’t have any policy solution or even the faintest recommendation – merely pointing out some rather interesting statistics.

The Economic Role of Government, Explained with a Tree

 

I am not an architect.

You own one of the 4 quadrants of the building, and other individuals own and live in the other quadrants. Despite my artistic ability, every quadrant is exactly the same size and is worth exactly 1/4 of the total value of the building. It is brought to the attention of all the residents that by planting a $5,000 oak tree in the courtyard will raise instantly raise the value of the building by $10,000.

Now assume you do not, nor are you able to, communicate with your neighbors. Unfortunately, if every resident were following their own self-interests, the market result is that no tree will be planted. In this case, the cost for any one individual to plant the tree ($5,000) greatly exceeds the benefit of having the tree ($10,000/4 = $2,500). While planting the tree makes sense collectively, it doesn’t make sense individually. This is where a Government steps in. A government can collect 1/4 of the cost of the tree from each resident ($1,250) and each resident will reap the benefit of having the tree ($2,500). Simple, right?

Well, there are some complications:

1) What if you can communicate with your neighbors and agree to plant the tree? Well, that eliminates the need for government. But what if one neighbor doesn’t want to pay? It still makes sense for the remaining 3 to each pay $1,667 to get a $2,500 benefit. But the person who pays zero still gets a $2,500 benefit too. Is this fair? Will the remaining three still plant the tree?

2) What if there is a government, but one neighbor is unable to pay. Should the government collect from the other three neighbors and plant the tree? Keep in mind, the three who pay are still getting a benefit that exceeds the cost.

3) What if the government is collecting from all 4 neighbors, who are all able to pay, but one neighbor has an opportuntiy exclusive to him that will raise the value of his quadrant alone by $12,500 if he spends the same $1,250 that his share of the tree will be (and if he pays for the tree, he then can’t pay for his own project)?

The economic role of government is to identify where we should “plant trees”, and then do so. The complications, as we’ve seen above, cloud the issue significantly. Different folks have different opinions of what to do in those three cases, and none of those opinions are necessarily wrong.

My personal opinion is that “what is fair” is not important – what matters is “what maximizes social welfare”. I would argue the optimal case, of those listed above, is to let the one neighbor improve his property to increase its value by $15,000 and then allow the other three neighbors to plant the tree. While it may be “unfair” that one neighbor sees the value of his quadrant increase by $15,000 while everyone else’s increased by $2,500 and all four invested the exact same $1,250 – but from a total social welfare perspective, it yields the greatest increase.

Does fairness trump total social welfare? Careful with your answer, because no matter if you are conservative-leaning or liberal-leaning, I can find an example that you won’t like, and you should be prepared to be consistent with your beliefs!

 

Peak Load Engineering

Imagine you are an engineer tasked with designing a municipal waste system. You are presented with the following data, which shows the actual, recurring future throughput of the system.

As we can clearly see, there are periods with clear, identifiably higher throughput. We want to design our system so that it always works, so engineering the system for the average throughput clearly won’t work. We need the system to be able to hand the peak loads, and thus we might size our pipe to accommodate the peak load. After performing all the necessary calculations, you hand in to your boss your design specifications only to have her come back and say that you need to go back to the drawing board. It’s too expensive, she says, as the cost of the project increases exponentially with incremental volume capacity through a larger pipeline diameter. You need to use smaller pipe, she says.

Back to your desk you go, and you already have the easy fix in mind. You design a system with smaller diameter pipelines, but more of them, so that the volume capacity of your original design is unchanged. You show this to your boss and she looks at you like you’re a complete idiot and asks if you even went to engineering school or if you won your degree in an eBay auction. You’re stumped.

So there you are at your desk, listening to Ministry’s Cover Up much like I am now, wondering how to solve this problem. There appears to be no way to design the system so that it works all the time while staying within your budgetary constraints. It simply cannot be done.

The problem here is that our engineer is only looking at one side of the problem, the system-side solutions, without any consideration to behavior-side solutions. If we could merely find a way to alter behavior so that the volume through the system was more spread out and consistent, as opposed to have periods of peak usage followed by periods of significant under-utilization.

Now, I don’t have an answer for how we alter behavior so people flush their toilets at different times, and this post is really about sewer systems. The graph above isn’t really one of loads (sorry, no pun intended, I promise) through a municipal system. It’s really this:

By now we are all quite familiar with the baby boom and the demographic conundrum it has presented us with in America. The huge number of aging baby boomers presents a potentially massive strain on our health care system, which is already having to operate more efficiently as a result of higher life expectancy in general. Simultaneously, the propensity of baby-boomers to work longer in their lives puts a strain on the American job market. 9% unemployment quite simply means that there are more job seekers than there are jobs available, and boomers working later into their lives only adds to the supply of labor with a corresponding increase in the demand for labor (which, in addition to leading to a jobs shortage, also has the effect of depressing wages). Furthermore, far too many people consider these two factors as a “damned-if-you-don’t, damned-if-you-don’t” where in reality the healthcare requirements of aging boomers and their propensity to work longer are not necessarily related. These are folks who are going to get older regardless of whether or not they work, so it’s a mistake to look at the problem as an either-or situation, both of these things are happening.

I made the analogy above not because I relate that generation with a peak load of sewage (really, I don’t), but because the proposals I often hear to deal with our demographics problem are all system-side solutions. And as such, we’ve built a system designed for the peak load of the baby-boom generation. When you engineer a system designed for a peak-load, your system is highly underutilized during other periods. This might be okay for an inanimate object like a steel sewage pipe – but what happens when we are talking about people. What happens when the “peak load” of our population is no longer present? Sorry to get morbid, but sadly the death rate of humans has stayed constant right at 100%, and our boomers will all eventually die.

When the baby boom generation is no longer here, we will have built a healthcare system, a job market and traditional infrastructure systems designed to handle a peak load that may never occur again. Eventually what that will mean is that we have hospitals, doctors and nurses we don’t need. It means we’ll have a complete reversal of the job market structure where we have a surplus of jobs and find we need to import labor in order to keep our economy running. It’s means we’ll have reduced traffic congestion (okay, that one might be wishful thinking).

For too long we ignored behavior-side solutions, focused only on designing systems to accommodate behavior as though it was a static, exogenous component that we could have no influence over: this is a huge mistake. What we should have done (and where we should take away a lesson for the future) is design the most cost-benefit optimized solution that incorporates both the system-side and the behavior-side. This is pretty easy for anyone to agree with, the next part is where I’ll lose about half of you:

My personal opinion is that the role of government is act where externalities are present in order to help maximize overall social welfare. That is any government, be it federal, state, local, or even just your homeowners association. In the case of the baby boom generation, how could we have guided behavior that matched the most effective “system”? One problem we have is baby boomers working later into their lives, putting more strain on the job market. We needed a behavioral solution that some way incentivized this generation into retiring earlier than they are. Another problem we have is the strain they will place on our healthcare system. We needed a behavioral solution that some way incentivized this generation to live healthier lifestyles thus reducing the strain they eventually place on the healthcare system. This is the role of government because a free market guided by individual incentives will predictably not provide these things (because the costs are external to the decision maker – an externality! The individual baby boomer doesn’t care if an individual 21 year-old can’t get a job because the boomer is working later into his life, because the costs are external to the boomer. The 21 year-old doesn’t want to fund a retirement program for baby boomers because the benefits are external to 21 year-old).

Yes, conservative-minded folks, I am making a case for “entitlement programs”. These programs are designed to solve the problem of externalities: the overall cost of the programs is less than the overall social benefits of the program. I put this last part in bold to highlight that this condition is REQUIRED for the “entitlement” program to be effective and a worthwhile endeavour. To want to completely abandon “entitlement programs,” is a tragic mistake because by promoting a completely laissez-faire system ignores the harsh reality that externalities exist.

You liberal-minded folks might view this post as a reaffirmation of Social Security, Medicare and other entitlement programs – but I have bad news for you too: those programs clearly did not work! They did nothing to solve the problem of the baby boom “peak load”. The protectionism over the entitlement programs as they currently exist is misguided, because those programs are not solving the problems they are intended to.

It is too late to redesign the system that will help us with the baby-boom peak load. What we need to focus on in America today is the system-side and behavior-side solutions that will help us deal with the huge under-utilization problem we face after the baby boom generation passes. The extreme-right idea of abandoning all “entitlement programs” and the extreme-left idea of protecting (or even expanding) existing “entitlement programs” are both equally misguided. It’s time to re-engineer the entire system, with appropriate behavior-side solutions in mind.

 

My Analysis of America’s Opinion of Our “Direction”

It Sunday and I refuse to do any kind of legit economic critical thinking, but I am perfectly willing to play amateur sociologist (BTW: Scott’s definition of sociology: economics without the calculus.)

I found this chart from the Washington Post especially interesting:

The interesting interpretations I made are:

1) We Americans are never satisfied. We almost ALWAYS think we are headed in the wrong direction.

2) It appears we Americans get bored with one guy over time. With the exception of Clinton, every president saw the opinion of “wrong” direction rise in the second half of their presidency, and only Clinton and Reagan ended with a higher “Right” % than they started with.

3) We Americans really don’t like people named Bush. Of the 6 presidents on this chart, America was most headed in the “wrong” direction under Bush I and Bush II.

But perhaps what stood out to me most:

4) We Americans really suck at picking presidents. I have been joking for years on the old George Carlin line, “Is this really the best we can do, America?” and this kind of puts some statistical evidence to our poor choices. With the exception of that appears to be only a couple of years (which look to be centered around Reagan’s re-election, Gulf War I, and Clinton’s second term that carried into the start of Bush II’s term), we are always headed in the wrong direction. We quite clearly SUCK REALLY BAD at picking people who can lead us in the right direction, and we have 2004 and 2012 as great anecdotal evidence of this. In 2004, when it appeared that there was no way Bush II could win re-election based on his own merits, the daft Democrats picked John Kerry to run against him. Going into 2012, it appears there is no way Obama can win re-election based on his own merits, but just look at the potential GOP nominees. So, is this really the best we can do, America?

 

The Relativity of Wealth

As discussion about income inequality, wealth disproportionality and limited social mobility move increasingly to the forefront of national debate (at the expense of those really important issues like gay marriage, birth certificates and the attack on Christmas), I have witnessed two critical issues preventing the debate from ever progressing to a point where it may actually yield solutions.

  1. There is a fundamental misunderstanding, with no effort being made to reconcile, of what “wealth” means.
  2. There is no clear and agreed upon “problem” by which we can then attempt to develop “solutions” – even amongst those who completely agree with one another.

These are critical flaws that tend to plague most debates, and often times we witness people arguing with each other simply because they are using the same terms with differing definitions or because they are throwing out answers to a question they’ve never heard (which is akin to throwing a dart in a crowded barroom and hoping there is a dart board somewhere).

The post that follows is not an agreed upon, pier-reviewed theory of wealth, it’s just my opinion. And unless you had the absolute joy of being in my Spring 2007 Honors Macroeconomics course, you’ve probably never heard my theory. Well happy surprise! Here is the concise version of my theory on the Relativity of Wealth.

Most people’s idea of what wealth means is consistent with what we’d find in any common dictionary (these are the definitions offered up by Random House):

1. a great quantity or store of money, valuable possessions, property, or other riches: the wealth of a city.
2. an abundance or profusion of anything; plentiful amount: a wealth of imagery.
3. Economics.
a. all things that have a monetary or exchange value.
b. anything that has utility and is capable of being appropriated or exchanged.
4. rich or valuable contents or produce: the wealth of the soil.
5. the state of being rich; prosperity; affluence: persons of wealth and standing.

Does having more stuff make someone wealthy? Does even having a “great quantity” of stuff make a person wealthy? A million dollars? A billion euros? A trillion galactospheron cubes? What if everyone else also has a trillion galactospheron cubes?

Not until the 5th definition to we get any sense of context with the introduction of the word “rich”. Unfortunately, if we are someone who is just learning our language, for example, our dictionary only defines “rich” as having wealth (circular reference much?). We know, inherently, that you aren’t “rich” by just having a lot of stuff (even our country’s poor have tons of stuff!). You are rich by having more stuff than everyone else, you are poor by having less  stuff than others. Rich and poor are relative, and so is wealth.

I’m not a dictionary writer (I’m hardly a blog writer, for Pete’s sake) so I won’t attempt to construct a nice definition of wealth, instead I’ll provide the characteristics of what wealth is:

  • Wealth is relative. You aren’t wealthy by having more stuff – you are wealthy by having more stuff than others.
  • Wealth is finite. The sum of all wealth is always equal to 100%. The existence of more “stuff” doesn’t make anyone (or all of us) any more wealthy, because wealth is the relativity of what we have versus what others have.
  • Wealth is exclusive. By acquiring more wealth you inherently do so at the expense of someone else.
  • Wealth can neither be created nor destroyed (but stuff can), only transferred. Even in a postapocalyptic world with little remaining of the stuff we know today, there will be the wealthy and the non-wealthy (rich and poor).

To illustrate, start in the hypothetical two-person utopia of Econmonkeyworld, there is only you and only me (lucky for you I’m so darn likable). Regardless of how much stuff is available to us, we’ll end up with some distribution of stuff that looks like this:

In this distribution, I’m rich and you are poor (obviously it would work out this way since I’m the one with an economics blog). Regardless of who is wealthy and who is not, or the degree of which one of us is wealthy, there are only two possible outcomes: we are either identical in our ownership of stuff, or one of us is rich and the other is poor. For you to get more wealth, you must take from my share of all the available stuff (keep in mind, this doesn’t mean you need to take my stuff – just that you need to take from my share of all the available stuff and if you currently have it then it necessarily means that I don’t).

The two person economy is easy enough to understand, but then someone inevitably points out how much wealthier the United States is today than it was 200 years ago. And this is true, not only do we have more stuff, but we also are wealthier – but that wealth comes at the expense of the rest of the world. No matter the population segment we choose, there will always be “rich” and “poor” within that segment. Take a look at the top 1% of American earners. The last person who falls into that segment is the poorest amongst that segment. It’s easy for us to point out that person still has tons of stuff compared to the other 99%, but couldn’t we say the same of America’s poor if we compare them to the rest of the world?

I point this out because it illustrates the problem with selectively choosing our populations when debating policy solutions, especially when the “problem” has never been defined. What, exactly, is the problem? Is it income inequality? Wealth disproportionality? Social mobility? Some larger sense of “fairness”? And if you choose any of those things, why are they important?

The goal of economics and economic systems is to maximize social welfare, or the overall well-being of society as a whole. Typical of non-economists is the assumption we are talking about financial instruments and physical stuff when we talk about this maximization, but economists are people too and we’re well-aware of the presence of the multitude of other factors that contribute to well-being. I think another way of saying “maximize social welfare” is to simply say “maximize quality of life”.

In the case of income equality, the data shows that a measurable, consistent, objective index of quality of life plotted against a measurable, consistent, objective index of income & wealth equality looks something like this:

We can actually replace “income/wealth equality” with a myriad of other factors and this chart still remains factually correct. It’s the basic, introductory economics theory of diminishing marginal returns and, eventually, disultility (or negative returns). The typical example I use in my classes is that of a pint of Peanut Butter Chocolate Ice Cream (the official flavor of Scott). One bite is not enough, and I get increased marginal utility with my second bite. But, if I eat the entire pint in one sitting, I get sick – not only physically but with an overriding sense of shame. There is some point where I ate too much ice cream.

Translating that idea to Income/Wealth Equality, the point is most easily illustrated at its extremes. With a too-narrow concentration of wealth (say, 1% of the population holding 99% of the wealth – a Disproportionality Index of 99) we can imagine how that would be destructive to quality of life. Even if you are part of that 1% elite – is your quality of life maximized? The rest of society is extremely poor relative to you and thus your ability to gain from trade and mutual interdependence is limited. On the flip side, we can see how total income/wealth equality can lead to a reduced level of quality of life. Sure, there are no poor, but there are also no rich. Even Sir Thomas More knew the impossibility of the fully functioning total-equality state when we called it “Utopia” – which literally translated means both “good place” and “no place” (not to mention More’s character telling us of this wonderful place is named Raphael Hythloday, whose last name literally translates to “speaker of nonsense”).

So there is quite understandably a “not enough” and a “too much” to the concept of income/wealth equality – but where is that dividing line?

I don’t have all the answers, man.

Flat Tax Basics

The best part about a simple tax plan is that it allows for a simple analysis.

I present this post as a response to discussions I have with students (and other people who occasionally want to care about economics) when they bring up the idea of a flat tax as opposed to our progressive tax system.

My answer is always simple – a flat tax is a tax increase for those who currently pay below the proposed rate, a tax break for those who pay more. Pretty obvious, I know, but judging by people’s reactions… I don’t think they know.

So here is a chart that attempts to explain the effects of a flat tax, with a hypothetical 20% tax rate replacing the graduated tax rates currently in place. Enjoy!

Click for Full Size Image

Income Inequality and the Error of Adhering to Whole Numbers

The chart above is one we’ve all undoubtably seen, especially if we’ve ever spent more than 5 minutes listening to the debate of income inequality in the United States. You’ll notice the chart above is unlabeled. I’ve done because this isn’t a chart of what you think it is.

But first some disclosures. I think it’s important for me to be upfront with where I stand politically in order to mitigate the inevitable discussion of bias and preconceived notions. I have lots of “Conservative” friends and lots of “Liberal” friends (and I put those terms in quotes because despite those words having discreet meanings before our modern political discourse twisted them to mean what they do today – I am referring to their modern definitions in a political context). The vast majority of the time, the most extremely entrenched and loyal on either side of the political spectrum hate what I say and accuse me of being on the other side. At the same, most of my moderate friends may not agree with me, but don’t find the points I try to make to be unreasonable. I find this a good sign that I’m in a good place. I am a hardened believer of Free Market economic systems, backed by strong and effective anti-trust protections and government intervention where externalities and natural monopolies prevail, amongst other things. I apply those same Free Market principals to individual behavior. I don’t believe it’s the governments behavior to tell people how to act, except in circumstances where those actions harm parties unrelated to a personal transaction (for example: I think murder is rightfully illegal, while I don’t care about gay marriage and don’t believe it’s a place for the government to have a say.)

Okay, with that out-of-the-way – let me say that I’m also keen to and a believer in the mountains of evidence that correlate greater levels of income inequality to lower quality of life. Richard Wilkinson has an excellent presentation on the data in this video:

The graph above is the % of Net Wealth Held by the top 400 Wealthiest Americans versus the 1.4 million Americans who make up the top 1%, with the small sliver representing the Top 400.

It may not seem like those 400 individuals own a disproportionately huge portion of the wealth in America, because the data is presented in a way that is physically incapable of demonstrating the level of disproportionality. What if we present the data this way instead:

This is my personal Disproportionality Index of Net Wealth. It’s an easy calculation, and one I use in a lot of research where proportionality is an important factor. In this case, it’s the Percentage of Net Wealth held by a segment of the population divided by the percentage of the population they account for in physical, living beings. Since we have five segments here, each accounting for 20% of the population, the sum of all the indices necessarily totals 5. So for the Top 20% to have a Disprorportionality Index reading of 4.215 means that 20% of the population owns 84.3% of the Net Wealth in America. Any Index reading less than 1 means that segment owns proportionally less than the percentage of the total population they make up.

Let’s look at the Disproportionality Index if we include the oft vilified Top 1%:

Predictably, the Top 1% shoots off the charts with an Index number of 34.3. We all know this, but the point of this post goes back to the first pie chart I presented and the story the pie chart fails to tell.

Where my original pie chart fails was in showing the massive level of Disprorportionality exhibited by the Top 400 Wealthiest Americans. Some might find it easy to dismiss the amount of wealthy they hold as statistically small because it represents on 1.6% of the Net Wealth held by all Americans. But we need to keep in mind that these individuals account for only 0.0003% of the earners in the United States, thus a Disproportionality Index figure of almost 6,000! So large it turns the Top 1%’s index number into a mere blip on the chart.

Why is This Important

As The Occupy Movement spreads across the country, Presidential Campaigns kick into high gear, our nation struggles with a sluggish economy, and cries of class warfare echo through the media – the strangely strict adherence to whole numbers (the 99% vs. 1%) creates division amongst people who might actually have common ground. The bottom 80% of earners are disenfranchised by their relative disproportionate lack of share of the nation’s wealth. If quality of life is an important goal, the data indicates we should strive for less income inequality (which is not the same thing as everyone making the same income).

When the message becomes the 99% versus the 1%, however, the message then aligns the bottom of the top 1% with the Top 400 – but they are actually quite different. So different, in fact, that the Average Net Wealth held by a member of the Top 400 is 2,646 times greater than the Net Wealth held by the last person who fits into the Top 1%. That person probably agrees with you that incomes inequality is too great, but you’ve now forced him or her into a defensive position by which they MUST side with the Top 400.

So What’s the Answer

admittedly, I don’t have the answer – or even an answer, because I don’t know the question. If we value Quality of Life, then the data indicates changes must be made to reduce the high degree of income inequality experienced in the United States. There will always be income inequality, and it will always be significant in a free market economy – the incentive of becoming rich is part of what drives a free market economy towards constant innovation and growth. But as I always describe to my students, a society is much like a piece of taffy. We can stretch it thinner and thinner, moving the sides further out from each other, but eventually the taffy will snap apart. Income inequality is that piece of taffy. We can stretch it only so much before it breaks.

So What’s This All About?

Hello world. You may know me, or you may not. I’m Scott from Freetail Brewing Co., a tiny little brewpub in San Antonio, Texas. When I’m not busy making beer, you can find me in the classroom teaching economics to college students who would probably prefer I talk about beer instead.

You may have seen my other blog, Brewed and Never Battered, which focuses on beer industry issues and the trials and tribulations of running a brewery. Rather than bore everyone over there with my economics musings, I decided to start this blog instead.

In what I promise to be in extremely sporadic fashion, you can find economic discussion here. Please direct more interesting beer industry related discussion to the other blog.

Cheers,

Scott