Financial Planning & Wealth Management

Solving Inequality

There’s a rule of thumb that says that if you run a company, then 20% of the people do 80% of the productive work, or that 20% of your customers are responsible for 80% of your sales, or that 20% of people are responsible for 80% of the customer service calls.

 

This is the Pareto principle which basically says that 80% of outcomes come from 20% of causes. You may have heard of the 80/20 rule? 

 

But that’s not exactly the rule when it comes to people. A variation on the Pareto Distribution is Prices Law which is worse than that. Prices Law states that in a given domain, the square root of the number of people operating in that domain do half the productive work. 

 

So, you have 9 employees, then 3 of them do the productive work. OK. What if you have 100 employees? Then 10 of them do half the work. What if you have 1000 employees – then it’s ~ 30. And if it’s 10 000 employees, then it’s 100.

 

The Pareto Principle and Prices Law provide valuable insights, though they each serve distinct purposes. The Pareto Principle serves as a sociological tool, explaining the uneven impacts of various factors, whereas Price’s Law acts as a measurement tool for analyzing contributions within a group of people.

 

And both these laws turn out to be rather iron clad rules. They apply across very many situations. They apply, for example, to the math of stars and the size of cities. So, you can see how universal they are as laws. 

 

It’s something like the idea that those who have more get more and those that have less get less. That’s the Matthew principle – “to those that have everything, more will be given; from those that have nothing, everything will be taken”.

 

The economists sometimes call that the Matthew principle.

 

What these laws lay out is a world that’s rife with inequality.

 

You hear the idea that the 85 richest people in the world have more money than the bottom 2 billion. That’s a Pareto distribution phenomena. 

 

And you might say, ‘to hell with capitalism’ for producing that. But then it’s like – sorry, you have your diagnosis wrong. It’s a natural law. No matter what society you study, you get a Pareto distribution of wealth.

 

You get a Pareto distribution of number of records recorded. For example, the top 20% of artists are responsible for 80% of records. You get a Pareto distribution for number of songs written or goals scored. Any creative product has that characteristic. And it’s partially because as you start to become successful, let’s say, people offer you more and more opportunities. And as you start to fail, people move away from you and you plummet.

 

That’s rough. What it means is there’s always a landscape of inequality. I’m not saying that we shouldn’t do anything about it. What I am saying is that we don’t know what to do about it. 

 

That’s the thing. Because you can modify the Pareto distribution of wealth, but we don’t know how to do it so much that it collapses. For example, that’s what happened with the Soviet Union or Mao’s China. 

 

Have you read about Stalin’s 5-Year Plans? Do you know about the Cultural Revolution? The cure was so much worse than the disease. If you don’t believe me, read Alexander Solzhenitsyn’s The Gulag Archipelago. The Russians had a rough time. The Chinese may have had worse.

 

The truth of the matter is we don’t know technically how much inequality there has to be to generate wealth. We can guess, and you can say there should be less. But we do know that it’s inevitable. And we also know that we don’t know how to regulate it.

 

Share this article on your favourite platform

About

 MattFin is a blog that focuses on wealth management, investments, financial markets and investor psychology. I build financial plans and portfolios for families and individuals

Recent Articles