Category Archives: Economics

The Rich Get Richer

Duckworth developed the “Grit Scale” and has found that a person’s grit score is highly predictive of achievement under challenging circumstances.

In this post I will employ a statistics-based argument  that money begets money.  Don’t worry, I’ll get back to blathering unquantifiable bullshit soon, but this is worth it!

Angela Duckworth is a world-class research psychologist at the University of Pennsylvania who is famous for her work on grit (perseverance and determination).  When she is not traveling around the world giving hilarious lectures, she is my statistics professor, which is pretty awesome for me.

In our last class, she was describing what you can learn about data just by looking at its shape on a graph.  For instance, why is the “normal distribution” important?  What causes the curved shape that you see below to come about?    She showed us this 6 second video in which thousands of little beads are poured over a bunch of nails.  When a bead hits each nail, 50% of the beads will go right, and 50% will go left.  There are many more paths to get to the center of the distribution, and those on the wings have to be really un/lucky and get bounced the same way each time.  And, because there are so many beads and so many factors involved, they tend to balance themselves out and by the end you get a perfectly normal distribution—the bell curve.  In other words, the normal distribution is a result of a bunch of unbiased factors that sort out any given population.

So, I wondered, what is the pattern of income distribution in the United States?  If it was a normal distribution, that would mean the top of the bell curve would be  $51,914, the median income of the country (2011 US Census).  Within one standard deviation (the average distance from the median income), you would find 68.2% of the country, as we did in the graph above and in the probability machine video.  That majority would be flanked by 27% on the sides with about 4% in the extreme wings.   In general we would want the standard deviation to be small, as this would point to greater income equality; people’s incomes would be closer to each other.  As you can see in the graph below, more of the population is in the wings for the dark blue line, which would mean incomes would be further away from each other.  The light blue line would be preferred, where people have less disparate incomes.

But what we see in the United States today is not close.

The data is skewed left.  I scoured the internet for a graph that was 100% representational of our income distribution, but that proved to be as likely as finding a to-scale model of the solar system: it’s just too big.  Those big bars on the right need to be spread out like the rest of the graph all the way to casino tycoon Sheldon Adelson who made about something around 7.2 billion this year (Forbes).  Which means this graph is only representational of 0.0027% of the US household income distribution curve.  In other words, if this graph spans 6 inches across your screen, you would need a computer screen 18,000 feet wide to see the full distribution (0.5ft/0.000027).

Sheldon Adleson is the chairman of the Las Vegas Sands Corporation, the parent company of Venetian Macao Limited which operates The Venetian Resort Hotel Casino and the Sands Expo and Convention Center. He also owns the Israeli daily newspaper Israel HaYom.  He made $21.6 billion in the last three years.

What does this mean?

Let’s go back to the youtube video and the beads bouncing off the nails.  From the basic statistics that I understand, radically skewed distribution implies that the history of beads matter.  If the the bead had bounced lucky last time, it was more likely to bounce lucky again, and vice versa.  This makes sense to me.  It is much more difficult to go from an income of $30,000/year to $40,000/year, than it is to go from $1,000,000,000/year to $1,000,010,000/year.  In other words, the further down the road to wealth you are, the more likely you are going downhill.

So, I have advice for those looking to make more money; the first step to making money is having money.  The rich get richer.  Of course, there are plenty of exceptions.

I am sending this post to Professor Duckworth and my assistant professor, Peggy Kearn.  I want to hear what they think and see if there are any other conclusions we might draw from the shape of income distribution in America.  

Money is Power—Since Last Week Maybe

So in addition to strategic planning with Habitat, and relaxing, this summer I have been drafting a manuscript on just-war theory and pacifism.  As part of that project, I am conducting a survey of about 150 major wars and conflicts throughout recorded history.  I want to get some sense of what actually causes wars and when they might be justified.  I have finished 40 so far and it is, in a word, fascinating.

I discovered the An Lushan Rebellion of 755-763 in China, where potentially 15% of the worldwide population was wiped out.   I also discovered that Afghanistan was a very peaceful and stable monarchy from 1933-1973 that was progressively modernizing.  Trouble started when a progressive king pushed democratic reforms, which led to communists finding their way into the government, which led to a backlash, which led to a communist coup, which led to a soviet invasion, and the rest is history.

I will post more random observations that may or may not find their way into the manuscript, but I wanted to share one right now that likely will not: it is interesting how in earlier epochs of history military power was surprisingly unconnected to money and economic power.  In an earlier time, though still unlikely, the little guy could really take on the big guy and win.  Today, economic might is tied directly to military might, and the rich country is, almost automatically, the more powerful. Obviously, the country that can produce more tanks, guns, aircraft, ammunition, food, etc., should generally win.  However, before the industrial revolution, a bigger economy did not guarantee your safety and better military technology was not automatically had through vibrant industry.  Consider these examples:

  1. Ancient greece before Pericles or the Aetolian League was, compared to it’s neighbors Egypt and Persia for example, a cultural backwater of poor sots, of city-states trying to scratch out a living on relatively infertile lands and a comparatively fish-less sea.  Egypt was already a well-established and wealthy civilization.  When the Athenians and Spartans fought the Persians, it was roughly equivalent to America fighting Honduras, and Honduras winning.  The greeks might not have had much money, or commerce, or industry, but they had the phalanx, and that was enough to defend themselves against the mighty Persian empire.
  2. Even within the Greeks, Sparta was the dominant power in Greece, and beat the Athenians at the height of Athenian power.  But they were famously poor.  Please enjoy the following quote from Thucydides that I love dearly (I neglected to include this when I first published this post).  It comes at the beginning of his brilliant account of the Peloponnesian War. It seems to me incredibly far-sighted. The man had a proper sense of history, and makes a clear point: wealth does not equal power.”Suppose the city of Sparta to be deserted, and nothing left but the temples and the ground-plan, distant ages would be very unwilling to believe that the power of the Lacedaemonians was at all equal to their fame. And yet they own two-fifths of the Peloponnesus, and are acknowledged leaders of the whole, as well as of numerous allies in the rest of Hellas. But their city is not built continuously, and has no splendid temples or other edifices; it rather resembles a group of villages like the ancient towns of Hellas, and would therefore make a poor show. Whereas, if the same fate befell the Athenians, the ruins of Athens would strike the eye, and we should infer their power to have been twice as great as it really is. We ought not then to be unduly skeptical. The greatness of cities should be estimated by their real power and not by appearances.”  Source.   Emphasis added.
  3. Alexander the Great, a Macedonian, conquered the persians, and the Egyptians, and the Greeks, and others too.  He did not have much more money.  Instead, he had a phalanx too, but one in which they got rid of their shields so they could hold longer spears.
  4. Rome, that pantheon of wealth and economic power, fell prey to relatively poor barbarian hordes.
  5. The mongols were poor nomadic peoples whose hordes conquered the wealthy Chinese civilization, the wealthy Persians, and many others.  Those steppe peoples had excellent cavalry, but very little money or economic power.
  6. The nomadic Arabs conquered Spain, North Africa, Egypt, Persia, the Byzantines, etc., and they also did not have incredible economic might.
  7. The English under queen Elizabeth went up against the mighty Spanish, who were far superior in money and arms, and yet were still defeated.

The list goes on…

It is hard to imagine this world because it is so different from our own.  Our basic understanding of geopolitics is thwarted.  Imagine if the richest countries in the world fearing invasion by poor neighbors who might covet foreign wealth.  This is a world where the United States would fear an invasion by Haiti, and where starving Haitians figure they might try their hand at an invasion, since, after all, it might succeed.

In theory, I like the old world.  I like the romance of powerful peasant countries.  But perhaps, in our new world order, war will become increasingly unlikely because a poor country can’t just invade a rich country because they covet foreign wealth.  But it also means that the rich will get richer, and their wealth will be unavailable to the poor, even if they are incredible soldiers led by Alexander the Great himself.

But maybe I am wrong.  But what about Vietnam?   What about Afghanistan?  Aren’t these modern examples of the little economy beating the big economy?  Perhaps, or perhaps these are exceptions that prove the rule, or perhaps victory of the little guy over the big guy is still possible—at least when the little guy’s military equipment is being shipped in from rival big guys’.

The Island of Yap

As I studied economics, I ran across this story a number of times.  Perhaps you have heard it.  It helps me think about the nature of money and valuation.

The indigenous people on the island of Yap developed money that consisted of enormous round slabs of limestone, up to 12 feet in diameter, with holes in the middle.  Limestone was not found on Yap, but on a neighboring island.  Quarry and transport costs accentuated its value.  Of course, nobody owned very many of these huge stones, called rai, but they did change hands for dowries, or as a last resort after a failed crop (though hopefully your crop was the only one that failed, otherwise you might be facing rai inflation).

But rai did not change hands per se.  They were too big.  Instead, when you acquired rai, it was merely acknowledged that the stone now belonged to you.  You left it in the town square, or marking the path, or wherever it lay.  It was yours and everyone knew it.  Now you had enduring stored value, ready for you when you needed it.

Once, while transporting a large rai stone, it fell into a deep part of the sea.  Oh no!  But after some discussion, everyone concluded it must be down there somewhere, and so it continued to be exchanged as if it was regular rai.  It is still traded, though nobody has seen it for over 100 years.

It seems to me that the brilliance of modern finance is to say, “Why are we going through the trouble of mining and transporting these stones (or in our case, precious metals) in the first place?  Seems like a waste of time.  Instead, why don’t we pretend that all our rai are already lying on the bottom of the sea?  We’ll just use banks, accountants, and ledgers to keep track of it all, just like we were doing already, but in order to lessen the impact of cycles of inflation and deflation, let’s create a quasi-governmental organization (the Fed) to control how much fictional rai at the bottom of the sea we are allowed to think exists.”  Brilliant.  If we are all going to play make-believe, we might as well ensure our make-believe world is as stable as possible.

Adventures in Economics

The realization irritatingly flicked my enormous nose two months ago: in order to realize my full potential as a snob, I need to learn more about economics and develop some stronger opinions.  The context for this realization was a year of Alicia taking the equivalent of intellectual steroids in her masters program–just plain unsportswomanlike.  I used to hold my own with her when debating monetary policy, development economics, and recent global economic history.  Now I’m an infant.  At least I could still play the “well I have some insight because at least I grew up in another economy” card.  But Eric, a friend from Taiwan, moved in and took that tiny advantage from me.  And, before Alicia went to Rwanda, they had impassioned debates that I enjoyed only as a spectator.  That’s just unethical.  All arguments should include me.

Seriously, economics is important, and I know very little.  I can’t pretend to be a well-informed citizen if I don’t have an informed opinion on, for instance, the gold standard.  Therefore, I went on a binge and listened to the following (feel free to skip the list):

Economics.  3rd Edition (36 lectures).  Timothy Taylor does a good job.  He’s managing editor of the Journal of Economic Perspectives.

Principles of Economics (14 lectures) With Peter Navarro (didn’t get all the way through it)

Freakonomics.  By Steven Levitt. Interesting!

The Ascent of Money: A Financial History of the World by Niall Ferguson.  I enjoyed it.  (I understand everything so much better when I understand the story of its development.  However, Ferguson could have been more systematic about it.  The phrase “financial history” makes you think it will be a history.  Its more of a collection of interesting tidbits of history.)

The Return of Depression Economics and the Crisis of 2008 by Paul Krugman.  Ok.

The Housing Boom and Bust by Thomas Sowell.  Statistics heavy.

The World is Flat by Thomas Friedman.  Mildly interesting!

Overall I was amazed with how boring economics can be.  I need my intellectual adventures to be a bit more adventurous.  This is why I love ancient Greece!  Nonetheless, I am now a bit more informed.  Here are some of my new positions and some old ones that were confirmed (new positions are in italics):

First, the gold standard is silly.  It takes away our ability to counteract inflation or deflation.  It might make more sense to the public, it might be easier to wrap our heads around, but it’s bad for the economy.

Second, the Fed is the best option we have.  Yes, it’s weird.  They do weird things.  But money is a fiction, and a shadowy quasi-government bank seems to be the best way to make it happen.

Third, the government needs to spend a ton during economic downturns.  It needs to cleverly bail out banks, GM, whoever, in order to ward off catastrophic failure.

Fourth, unions suck.  Sure, it’s a generality, but this is economics.  Formerly essential, currently destructive, unions are hurting us in most sectors (in America) where their presence is strong.

Fifth, any sort of protectionism is a subsidy.  It’s a tax on everyone else.  This does not mean that I am necessarily always against it, but we should call protectionism taxation.  As a corollary, we should generally be for free-ish trade.

Sixth, I am still a huge fan of the fair tax.  Huckabee/Petraeus 2012!

Seventh, I’m thinking more and more that privatizing social security might be a good idea.  The idea behind social security is that the younger generations owe the older generations that can’t work a decent standard of living for raising them.  I have two problems with this.  One, this moral obligation breaks down when so many in the older generation play no role in the creation and maturation of the younger generation.  In other words, those who don’t have kids or contribute to the raising of kids, should not be a forced burden on the kids of others.  This is happening, of course, en masse with the boomer generation.  Now, more than ever, our kids are our retirement plans.  Those who don’t have them need to be expected to make their own plans.  My second problem with social security is that we have proven inept at reforming it.  I would love to help those forced into retirement for health reasons.  But the retirement of able-bodied men and women is an incredible luxury, not a right.  We would need an overhaul of social security even if it was not going belly-up momentarily.

Eighth, tax cuts generally aren’t ideal for stimulating the economy.

Ninth, we need a big gas tax.

Tenth, because the market’s invisible hand will simultaneously give you cookies (progress) and stab you in the back (economic collapse and rising inequality), my general policy is this, as said by Drew Ludwig in response to Random Man’s question:

Random Man: Do you believe in socialism or capitalism?

Drew: I believe in the power of a well-regulated free market economy.

I think this makes me a moderate.

Venetian Money Stuff

Today, money is super easy to use in part because the money itself has no value.  It’s just paper and copper or nickel.  For most of human history, including Venetian history, money had intrinsic value and this made transactions very annoying.  Merchants had to be experts in weighing and measuring gold and silver, they had to understand alloys, and they had to carry around apparatus for doing these tests, and they had to perform them at every transaction.  In fact, assessing the value and worth of money was such an art that a whole industry cropped around this area of expertise: they were the moneychangers.  They would take a look at what you got and let you know what you could get with it.  They could also change what you had into something that might be locally more acceptable.  In Venice, many merchants were also moneychangers as a side business.

Most cities had moneychangers, but the Venetians took it further.  They started to leave their money with the moneychanger and only come back and get some when they needed it, thus inventing deposit banking (they beat Florence to it).  The Venetians did not know it at the time, but deposit banking, when you do not need returned the exact same gold and silver you put in, is very important, and continues being important, for economic progress as it keeps capital working in the economy.  Instead of thousands of dollars sitting under your mattress doing nothing, it is funding an expedition or something.

Then the Venetians found it much more convenient to settle transactions by what I am calling the mediaeval debit card, that is simply walking up the moneychanger with your business associate and say, “take 94 duckets out of my account and give it to him.”  In fact, since many of them knew each other so well, they started just to write out their agreements on slips of paper and giving them to each other (checks).  In these two ways they invented moneyless transactions where nothing changed hands.  Instead, a moneychanger scribbled something in his ledger and that was that.  By the way, the main bench on which the Venice’s moneychangers sat was called the “Banka,” which of course gave us the word “bank.”

Being part of the mediaeval Catholic world, Venetians were not allowed to charge each other interest on loans.  This is a problem for merchants, as they need large loans with which to start buying low.  Therefore, merchants would look for investors who would front the money.  In other parts of the world, investors expected 20% interest on their loans regardless of profit.  In Venice, investors expected a large portion of profits only, usually 75%.  Of course, it’s not smart to put all your money into one basket, so these investors started diversifying by putting some money in a bunch of different trading expeditions.  In other words, they bought and sold shares.  Stocks and the stock market started with Venetian merchant shipping.  One wealthy merchant died in the 15th century with shares in 132 different voyages.

The Venetians made many other important advancements in finance, including how to regulate banks by requiring them to keep a certain percentage of their money in reserve.  They also invented double entry bookkeeping, wherein they record all expenditures and revenue, requiring books to be constantly balanced.   You can see how this would make business more fraud resistant.  Without this type of bookkeeping, modern finance would be impossible.  Complex businesses would not work.  Double entry bookkeeping also works best with arabic numerals, and the Venetians were one of the first Europeans to import them.   Finally, they started selling liability insurance for merchants, a first since ancient times.

I was very much suprised to find Venice’s ongoing legacy in the world of finance.  The history of the city has been fascinating to study.  But I’m moving on now.  I am currently reading a book about Ayn Rand called Ayn Rand and the World She Made by Anne C. Heller.  Heller’s approach is very even, both praising and criticizing.  I tried to read Atlas Shrugged a few months ago and found it yawn inducing.  This is better.  It’s history, biography, and I get all the ideas without having to wade through her fiction (or non-fiction for that matter).