Income inequality and physics

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:

 600px-Energy_distribution_of_Boltzmann_gas.svg

Distribution_of_Annual_Household_Income_in_the_United_States_2012

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.

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8 thoughts on “Income inequality and physics

  1. As you can imagine I’m opposed to the redistribution of wealth. One can deny that this is socialism, but it essentially is socialism, which is defined in the Merriam Webster dictionary as 1) any of various economic and political theories advocating collective or governmental ownership and administration of the means of production and distribution of goods. 2) a system of society or group living in which there is no private property. 3) a system or condition of society in which the means of production are owned and controlled by the state. 4) a stage of society in Marxist theory transitional between capitalism and communism and distinguished by unequal distribution of goods and pay according to work done.

    If we use these definitions, then the redistribution of wealth can be called socialism: government owns all the wealth and property and can do with it as they please (good or bad). It’s certainly not capitalism. And can you tell me who at Fox News thinks socialism or wealth redistribution means that we all earn the same income? I watch Fox News but don’t recall anyone thinking that’s what it means. I wouldn’t describe it that way, nor would any conservative I know. Of course there are rich people under socialism, but that’s determined by the government, and typically they distribute the wealth to themselves and their political allies. I guess I’m not following your criticism of conservatives, Fox News, or the definition of socialism.

    Yes, inequality is inevitable. Although most liberals I know act as if it’s their responsibility to do something about it. But I’m not sure what you mean that inequality is especially so under Capitalism, as if Capitalism is the problem. When we have a real Capitalistic society, the wealth isn’t directly controlled by the government. In other forms of economic systems, however, the government controls the wealth and maintains that inequality for themselves. I think that’s much worse. The problem with our form of Capitalism is that government is so big that it’s able to find ways to capture the wealth for themselves, and that’s why the greatest concentration of wealth in America is in Washington D.C. And that’s also where the greatest crime and murder is located… interesting, huh?

    If the central question of the film asks how much inequality is good, I’d say that no inequality is good. It’s inevitable, but not good. It is what it is, and Capitalism is the best economic system we have, despite its imperfections. I have no idea at what point inequality begins to hinder an economy, but I’ve never cared to consider that question and don’t even know if it’s a question worth asking. Even if wealth is concentrated in the top 1%, everyone else is able to earn whatever they think they’re worth, and they’re free to spend their money as they choose (unless the government interferes). I’d be more concerned how bad journalism and politics can hinder an economy.

    Okay, so Reich doesn’t “hate” rich people. He’s one of them. So? What I’d want to know is if he participates in class envy, causing other people to hate the rich, while he benefits financially.

    You say, “Wealth isn’t a bad thing, it’s how people use it that should concern us”. Okay, there’s some truth there. Sure, the more money one has the bigger their political say. I may not like it, but that’s how it is. I’ll deal with that. If you have more money than me, I guess you’re entitled to do what you want with your money, just like I am.

    However I disagree that these individuals or groups with massive wealth can undermine every vote I make. That’s absurd, and it goes against what we know to be true. Case in point is Eric Cantor vs. Dave Brat. Here’s the House Majority leader with gobs of money who lost to a political unknown; an economic and ethics professor who was outspent by Cantor $5 million to $100,000.

    It seems that Cantor lost touch with his constituents and strayed from conservatism. Brat is a free market guy who adheres to the Republican Creed in Virginia. Therefore, if you and Reich are right, how do you explain this upset? I say it can be explained because the people of Virginia found someone who was willing to listen to them rather than the big donors. They were tired of their representative ignoring the will of the people on immigration and fiscal responsibility. And they made their voice known.

    This is the message we need to take away from this. If politicians listen to what the people want, they will get elected. The problem is finding worthy candidates willing to listen to us. Big money can be defeated if we have the right message.

    As for this new field of econophysics, I’d like to see if it can offer any real predictions, if it’s just theory, and if it has any value.

    1. I don’t think the government in countries with socialism hand picks who gets to be rich. I’m not sure if that’s what you were insinuating, but it sounded like that. If not, please clarify.

      “Even if wealth is concentrated in the top 1%, everyone else is able to earn whatever they think they’re worth.” If all of the wealth is concentrated at the top, then what exactly are these people earning? That’s where I lose the thread in the argument you’re making. Data shows that new wealth is being generated by this economy, but if you look at where it’s going you’d see it’s mostly going to the same few people. Is that because everyone else doesn’t think they’re worth more money? I highly doubt that. Which gets to what I mean that inequality is especially necessary in capitalism: if a free market determines wages, then there will always be income inequality. That’s not an indictment of capitalism, and that’s not even an indictment of inequality. As most economists, Reich included, would argue, some degree of inequality is natural and good to a degree economically.

      As for Brat, I’ll reserve my judgment until he wins and actually gets sent to the hill. Until then, it’s all just campaign rhetoric. I don’t know why anyone would assume that just because a hitherto unknown candidate wasn’t backed by big business in a primary election that somehow he or she will be immune to it once they entered office. Congress in and of itself is an odd beast–they have a 10% approval rating, yet an 80% re-election rate for incumbents. How do you explain that?

      In short, I agree with you that politicians who listen to the people will get elected. But what they do and say during the election cycle is zero indication of how they’ll actually behave under the influences of lobbyists and other external influences up on the hill. I guess one could could argue that they’d lose in the next cycle, but if this were true one would think that based on the approval rating of congress, 90% of them would be tossed out come this November.

      As a final thought, I’m curious. Some of your comments lead me to ask whether you think taxes should exist at all. Any form of taxation is redistribution of wealth. If you’re against redistribution of wealth, would it be fair to say you’re also against any and all forms of taxation? And if not, then why?

      1. I guess I was exaggerating slightly when I said that the government gets to decide who gets rich in socialist countries. There are those who get rich despite the government, but the point I was trying to make is that, when it comes to socialism, the government has tremendous control over how that wealth is distributed. They can create laws and raise taxes to increase their own wealth and power, or to benefit their friends, family and political allies. Sometimes it’s meant to look as if they’re helping the poor so that no one objects, but they know how to work the system so that the right people capitalize on the wealth they’ve been granted access to.

        What are the people earning if all the wealth is concentrated at the top? They’re earning whatever wage they’ve agreed to work for. If they agreed to work for $12.00 an hour, then that’s what they’re making. If they agree to work for $50.00 an hour, then they get paid for putting in those hours. If they’re able to run their own profitable business and make $250,000 a year, then that’s what they make. These people are earning money, not marbles. And then they get to spend that money. In a free society they get to decide how to spend their money. I’m not sure what’s hard to understand about this.

        If you’re upset about wealth going to the top 1%, then stop demanding government do something about it. Whenever government meddles with the economy, they screw it up worse. We need smaller government if we want to make progress. The rich have gotten richer under Obama, and that’s because the rich know how to benefit from new laws. If a new law is created to suppress the wealth, some huge corporations will support it because they know it will put their smaller competitors out of business, and they’ll profit from it. Raising the minimum wage, for example, will only hurt the very people it’s intended to help because it’s purely superficial, and the left wing politicians who support it believe they’ll be reelected at the expense of those they’re keeping poor. Just follow the money and you’ll see that this is all true. Inequality is especially true with socialism. I say let the free market sort things out on its own and we’ll be much better as a country. With capitalism, there may always be inequality, but not to the extent of socialism. Just look what six years of Obama has done to solve this inequality. Surely you don’t think more of the same is the key?

        I wasn’t suggesting that if Brat is elected to office that he’ll be immune to corruption. Eric Cantor was in that same position once, but he let the political machine control him, instead of listening to the people. Hopefully the same won’t happen to Brat. If it does, then we elect someone else with the same vision he brought to the office. It’s rare that someone actually delivers on their promises, and that’s why I like some of the true conservatives out there, such as Scott Walker.

        The 80% re-election rate of incumbents can be explained by voters who couldn’t articulate their vote with substance. We have a mostly illiterate voting base that votes by identity over substance. And that means politicians can take advantage of the voter’s ignorance. Most voters don’t understand politics enough to cast an educated vote, and they don’t know when a politician is taking them for a ride.

        I do believe taxes are a necessary evil. But we’re wayyyy overtaxed. I think we should be taxed fairly by a flat tax or a fair tax. We need a strong national defense, police, fire fighters, roads and such, but there are other things that would be better run by the private sector. To me, the private sector is the key, because they make things that work, or go out of business. The government doesn’t ever have to make anything work. As long as it’s broke, then we need to keep re-electing them to fix it, right? Therefore there’s no incentive for them to fix anything.

    2. To answer one of your other question, once one looks at the data it becomes overwhelmingly clear when income inequality becomes bad: when there isn’t enough purchasing power to drive economic growth. It’s not coincidental that the periods of greatest income inequality or wealth concentration were in 1927 and 2007, right before the Great Depression and the Crash of ’08.

      I think that one could make the argument right now that what really needs to end is speculation. Speculation is what creates bubbles, bubbles are what cause recessions, and speculation is also a way to redistribute income up the ladder to those at the top. It creates that “unnatural inequality” that econophysics talks about. I think if we made speculation illegal, the income distribution graph would lose that tail and end up looking exactly like the gas particle distribution graph (I also think if you looked at the data, pre-1970 graphs would also mirror the gas particle graph more closely). Ending speculation wouldn’t end capitalism or be a step toward socialization.

  2. I liked what you said about people not behaving rationally and thus the comparison to molecules in a gas makes some sense. I guess after listening to this guy about econophysics I think it’s important to note however that he really isn’t doing physics, or turning economics into a legitimate science, he is still applying a mathematical model to economics that is not rooted in any physical principles. When I was studying tornado dyanmics for my masters degree we also had a mathematical model to try to describe tornadic wind flows, but it was only something that approximated what few measurements we had rather something that was rooted in equations that actually describe atmospheric processes. That being said, models can be very accurate, and can at least give us a better insight to how things work. Given that economics is not really a science, approximating economic systems with mathematical models is about as good as it gets.

    The fact that the end of the distribution works according to a different statistical curve is not surprising. Once you have enough money your ability to grow that money increases exponentially. Furthermore you can actually start to make a big impact on policy by lobbying for tax laws that let you keep even more of your money. This has been happening for some time in this country. Keeping money out of politics is really the answer. How to do that, I don’t know, but there can never be any true oversight as long as lawmakers can be bought. Unchecked capitalism works nowhere. And yes speculation is also a problem, because money is being made on profits that haven’t been even made yet. And when you have a lot of money you can make a lot of money based on short term gains, sell your stock at a profit, while all those biters who bough small amounts of shares, based on the fact that they saw the stock is rising be the one’s to lose the money. With great amounts of buying power you can essentially move the market in the direction you want. My wife was a financial wizard in World of Warcraft and used to simply drive up prices in commodities by buying up what everybody else was making and then selling it all back at a high price. She could essentially change the economy on the server for certain goods, and once she had enough money she could buy out as much of the competition as she wanted and still have lots of money left to spare. And she had enough money to wait out the time it took to sell all of the extra good she bought back by selling a few of them everyday. And as a result she made even more money. It’s clear that as income inequality increases and the rich also get richer exponentially.

    So econophysics is interesting. Not science, but a step in the right direction towards a mathematical model that makes more sense.

    1. Fair point about the science behind this, but I think that a statistical model has much more applicable and ability to explain and predict than anything in current economic theory. It’s a developing field, and I’m most curious to see where it goes. I don’t really know what the solution to money in politics is either. The voting record of each member of congress is available…maybe people should review them before each election? At least then you’d have a chance of seeing if the votes the incumbent cast were for your benefit or for the benefit of corporations.

      1. I agree…I think it’s a step in the right direction. I’ll be interesting to see what comes of it too.

        I like your suggestion about people getting informed about who they vote for…but that would require people to be informed about who they vote for. When would that ever happen?! lol Honestly I think it would require some sort of constitutional amendments but that’s about as likely as informed voters. I don’t know…but at some point we have to say that the constitution and most amendments are over 200 years old. The world has changed. We need to revisit this document and make some changes. That would require politicians to actually want what’s best for the people. That seems as likely as informed voters as well. We’re probably just screwed! 🙂

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