I was watching Robert Reich’s film Inequality For All on Netflix the other night, and something he said particularly stood out for me. But first, a little context.
Reich worked as Secretary of Labor under Bill Clinton. He was a Rhodes Scholar and has a background in law and economics. A good deal of the movie focuses on what happens to an economy when too much of the wealth is concentrated in fewer and fewer hands (hint: the periods of greatest wealth concentration were in 1927 and 2007).
Everyone–liberal or conservative–will acknowledge that inequality is inevitable, especially under capitalism. Capitalism doesn’t work without inequality. The central question of the film is how much inequality is good? At what point does inequality begin to hinder an economy? Reich goes on the talk about the virtuous cycle and vicious cycle and how different levels of inequality play into them. But there was something else that he said, something that particularly resonated with me. The biggest point that Reich made in the film was this: wealth isn’t a bad thing, it’s how people abuse it that should concern us.
What is meant by this? Well, quite frankly, that the more money you have, the bigger political say you have. Recent SCOTUS rulings are obliterating democracy. Citizens United is a prime example. There’s too much money in politics. And it’s not just conservative money–there’s liberal money as well. But the overwhelming point of all of this is to say that there are groups, individuals, who can pretty much undermine every vote you make by whipping out their checkbook. How does that even remotely resemble a functional democracy? The short answer is that it doesn’t. The theme here is that there’s nothing at all bad about wealth–but it shouldn’t play a role in politics (at least not to the extent that it currently is).
Let’s add a little more flavor to this conversation. Most people who dislike Reich and his ilk will be quick to talk about the American Dream and economic mobility and the like. You know that old, “If you work hard enough, you, too, can make it and strike it big!” mantra that people like to spout off. And yes, there are a few exceptions of people doing this. A few. By and large, upward mobility will remain relatively stagnant, and most of the new wealth generated in this country will go to the upper 1%. Why is that? Because there are literally two economies in this country.
And no, I’m not speaking philosophically here. People who follow this blog will know that I don’t believe that there is anything scientific about economics–economics presumes that people will act rationally, but people act irrationally all the time, therefore any potential scientific value in economics flies out the window. However, I read something recently that piqued my interest. A new field called econophysics is emerging that attempts to scientifically explain the economy using concepts found in physics. So what do these scientists have to say about income inequality and the two economies?
You can think of an economy as particles of gas. Just like the motion of gas particles is random, so too are economic transactions. In this model, you can think of money as energy. If you consider the energy distribution of gas molecules at any random moment in time, you’ll find that a very few have very high energy, a very few have super low energy, and the vast majority are in between. Sound familiar? It’s basically your upper, lower, and middle economic classes. If all of this sounds a little fantastic, consider the following graphs:
The first graph is the energy distribution of gas particles. The second graph is income distribution in the US. Similar shapes, right? Yes, except for that weird tail on the high end of the income distribution graph, which represents approximately the top 3% of all earners. Why does income distribution match energy distribution so closely except for that one part? Because there are two inequalities that can be represented by two different functions.
There’s a normal or natural inequality that exists within all systems (remember, inequality in and of itself is not a bad thing, as even Reich will point out). This can be represented by an exponential function and it’s what causes the shape of the gas particle graph. However, there is also abnormal or unnatural inequality, and it’s represented by a powers function, which is what’s giving the income graph that tail at the end. But why are there two different functions to explain the graph?
Quite simply it’s because there are two sources of income or wealth in the economy. For 97% of this country–the percentage that follows the gas particle energy distribution–income is in real dollars or some other form of tangible wealth. But for the upper 3%, income is derived from essentially non-existent sources, like the stock market. This introduces a greater amount of variability into that upper 3%. At the same time, however, it also means different things for growth. If you’re paid in real dollars, your income is limited to the amount of money that physically exists in the real world. However, if your wealth is derived from a non-physical source–like the stock market–the growth potential is unlimited.
And this is exactly why most of the new income or wealth generated in this country goes to that top 3%. The Dow Jones and other financial markets have never done better and continue to grow and grow. Think about the economic recovery after our latest crash. Unemployment continued to grow and then stay stagnant, even as the stock market set new record highs. Average household income remains stagnant while the top 3% or 1% continues to grow unfettered. Econophysics explains why this happens beautifully.
So what does econophysics have to do with Reich and his film? Well, econophysics suggest that just as in any natural system, economic inequality is inescapable. And Reich seems to echo that sentiment, especially under the auspices of capitalism. Reich argues that although inequality is natural, too much of it will hinder an economy. But moreover, greater and greater wealth concentration will erode democracy. Econophysics explains why such disparities happens in mathematical terms. For a quick introduction to econophysics, click here.
*Edit: this post has been updated because I realized I violated my own “no politics” rule.