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.