Macro Roundup

Argument for wealth redistribution

Anu Partanen and Trevor Corson, "Finland Is a Capitalist Paradise,"New York Times, December 7, 2019, https://www.nytimes.com/2019/12/07/opinion/sunday/finland-socialism-capitalism.html

Finland Is a Capitalist Paradise

HELSINKI, Finland — Two years ago we were living in a pleasant neighborhood in Brooklyn. We were experienced professionals, enjoying a privileged life. We’d just had a baby. She was our first, and much wanted. We were United States citizens and our future as a family should have seemed bright. But we felt deeply insecure and anxious.

Our income was trickling in unreliably from temporary gigs as independent contractors. Our access to health insurance was a constant source of anxiety, as we scrambled year after year among private employer plans, exorbitant plans for freelancers, and complicated and expensive Obamacare plans. With a child, we’d soon face overwhelming day-care costs. Never mind the bankruptcy-sized bills for education ahead, whether for housing in a good public-school district or for private-school tuition. And then there’d be college. In other words, we suffered from the same stressors that are swamping more and more of Americans, even the relatively privileged.

As we contemplated all this, one of us, Anu, was offered a job back in her hometown: Helsinki, Finland.

Finland, of course, is one of those Nordic countries that we hear some Americans, including President Trump, describe as unsustainable and oppressive — “socialist nanny states.” As we considered settling there, we canvassed Trevor’s family — he was raised in Arlington, Va. — and our American friends. They didn’t seem to think we’d be moving to a Soviet-style autocracy. In fact, many of them encouraged us to go. Even a venture capitalist we knew in Silicon Valley who has three children sounded envious: “I’d move to Finland in a heartbeat.”

So we went.

We’ve now been living in Finland for more than a year. The difference between our lives here and in the States has been tremendous, but perhaps not in the way many Americans might imagine. What we’ve experienced is an increase in personal freedom. Our lives are just much more manageable. To be sure, our days are still full of challenges — raising a child, helping elderly parents, juggling the demands of daily logistics and work.

But in Finland, we are automatically covered, no matter what, by taxpayer-funded universal health care that equals the United States’ in quality (despite the misleading claims you hear to the contrary), all without piles of confusing paperwork or haggling over huge bills. Our child attends a fabulous, highly professional and ethnically diverse public day-care center that amazes us with its enrichment activities and professionalism. The price? About $300 a month — the maximum for public day care, because in Finland day-care fees are subsidized for all families.

And if we stay here, our daughter will be able to attend one of the world’s best K-12 education systems at no cost to us, regardless of the neighborhood we live in. College would also be tuition free. If we have another child, we will automatically get paid parental leave, funded largely through taxes, for nearly a year, which can be shared between parents. Annual paid vacations here of four, five or even six weeks are also the norm.

Compared with our life in the United States, this is fantastic. Nevertheless, to many people in America, the Finnish system may still conjure impressions of dysfunction and authoritarianism. Yet Finnish citizens report extraordinarily high levels of life satisfaction; the Organization for Economic Cooperation and Development ranked them highest in the world, followed by Norwegians, Danes, Swiss and Icelanders. This year, the World Happiness Report also announced Finland to be the happiest country on earth, for the second year in a row.

But surely, many in the United States will conclude, Finnish citizens and businesses must be paying a steep price in lost freedoms, opportunity and wealth. Yes, Finland faces its own economic challenges, and Finns are notorious complainers whenever anything goes wrong. But under its current system, Finland has become one of the world’s wealthiest societies, and like the other Nordic countries, it is home to many hugely successful global companies.

In fact, a recent report by the chairman of market and investment strategy for J.P. Morgan Asset Management came to a surprising conclusion: The Nordic region is not only “just as business-friendly as the U.S.” but also better on key free-market indexes, including greater protection of private property, less impact on competition from government controls and more openness to trade and capital flows. According to the World Bank, doing business in Denmark and Norway is actually easier overall than it is in the United States.

Finland also has high levels of economic mobility across generations. A 2018 World Bank report revealed that children in Finland have a much better chance of escaping the economic class of their parents and pursuing their own success than do children in the United States.

Finally, and perhaps most shockingly, the nonpartisan watchdog group Freedom House has determined that citizens of Finland actually enjoy higher levels of personal and political freedom, and more secure political rights, than citizens of the United States.

What to make of all this? For starters, politicians in the United States might want to think twice about calling the Nordics “socialist.” From our perch, the term seems to have more currency on the other side of the Atlantic than it does here.

In the United States, Senator Bernie Sanders and Representative Alexandria Ocasio-Cortez are often demonized as dangerous radicals. In Finland, many of their policy ideas would seem normal — and not particularly socialist.

When Mr. Sanders ran for president in 2016, what surprised our Finnish friends was that the United States, a country with so much wealth and successful capitalist enterprise, had not already set up some sort of universal public health care program and access to tuition-free college. Such programs tend to be seen by Nordic people as the bare basics required for any business-friendly nation to compete in the 21st century.

Even more peculiar is that in Finland, you don’t really see the kind of socialist movement that has been gaining popularity in some of the more radical fringes of the left in America, especially around goals such as curtailing free markets and even nationalizing the means of production. The irony is that if you championed socialism like this in Finland, you’d get few takers.

So what could explain this — the weird fact that actual socialism seems so much more popular in the capitalist United States than in supposedly socialist Finland?

A socialist revolution was attempted once in Finland. But that was more than a hundred years ago. Finland was in the process of industrializing when the Russian empire collapsed and Finland gained independence. Finnish urban and rural workers and tenant farmers, fed up with their miserable working conditions, rose up in rebellion. The response from Finland’s capitalists, conservative landowners and members of the middle and upper class was swift and violent. Civil war broke out and mass murder followed. After months of fighting, the capitalists and conservatives crushed the socialist uprising. More than 35,000 people lay dead. Traumatized and impoverished, Finns spent decades trying to recover and rebuild.

So what became of socialism in Finland after that? According to a prominent Finnish political historian, Pauli Kettunen of the University of Helsinki, after the civil war Finnish employers promoted the ideal of “an independent freeholder farmer and his individual will to work” and successfully used this idea of heroic individualism to weaken worker unions. Although socialists returned to playing a role in Finnish politics, during the first half of the 20th century, Finland prevented socialism from becoming a revolutionary force — and did so in a way that sounds downright American.

Finland fell into another bloody conflict as it fought off, at great cost, the Communist Soviet Union next door during World War II. After the war, worker unions gained strength, bringing back socialist sympathies as the country entered a more industrial and international era. This is when Finnish history took an unexpected turn.

Finnish employers had become painfully aware of the threats socialism continued to pose to capitalism. They also found themselves under increasing pressure from politicians representing the needs of workers. Wanting to avoid further conflicts, and to protect their private property and new industries, Finnish capitalists changed tactics. Instead of exploiting workers and trying to keep them down, after World War II, Finland’s capitalists cooperated with government to map out long-term strategies and discussed these plans with unions to get workers onboard.

More astonishingly, Finnish capitalists also realized that it would be in their own long-term interests to accept steep progressive tax hikes. The taxes would help pay for new government programs to keep workers healthy and productive — and this would build a more beneficial labor market. These programs became the universal taxpayer-funded services of Finland today, including public health care, public day care and education, paid parental leaves, unemployment insurance and the like.

If these moves by Finnish capitalists sound hard to imagine, it’s because people in the United States have been peddled a myth that universal government programs like these can’t coexist with profitable private-sector businesses and robust economic growth. As if to reinforce the impossibility of such synergies, last fall the Trump administration released a peculiar report arguing that “socialism” had negatively affected Nordic living standards.

However, a 2006 study by the Finnish researchers Markus Jantti, Juho Saari and Juhana Vartiainen demonstrates the opposite. First, throughout the 20th century Finland remained — and remains to this day — a country and an economy committed to markets, private businesses and capitalism.

Even more intriguing, these scholars demonstrate that Finland’s capitalist growth and dynamism have been helped, not hurt, by the nation’s commitment to providing generous and universal public services that support basic human well-being. These services have buffered and absorbed the risks and dislocations caused by capitalist innovation.

With Finland’s stable foundation for growth and disruption, its small but dynamic free-market economy has punched far above its weight. Some of the country’s most notable businesses have included the world’s largest mobile phone company, one of the world’s largest elevator manufacturers and two of the world’s most successful mobile gaming companies. Visit Finland today and it’s obvious that the much-heralded quality of life is taking place within a bustling economy of upscale shopping malls, fancy cars and internationally competitive private companies.

The other Nordic countries have been practicing this form of capitalism even longer than Finland, with even more success. As early as the 1930s, according to Pauli Kettunen, employers across the Nordic region watched the disaster of the Great Depression unfold. For enough of them the lesson was clear: The smart choice was to compromise and pursue the Nordic approach to capitalism.

The Nordic countries are all different from one another, and all have their faults, foibles, unique histories and civic disagreements. Contentious battles between strong unions and employers help keep the system in balance. Often it gets messy: Just this week, the Finnish prime minister resigned amid a labor dispute.

But the Nordic nations as a whole, including a majority of their business elites, have arrived at a simple formula: Capitalism works better if employees get paid decent wages and are supported by high-quality, democratically accountable public services that enable everyone to live healthy, dignified lives and to enjoy real equality of opportunity for themselves and their children. For us, that has meant an increase in our personal freedoms and our political rights — not the other way around.

Yes, this requires capitalists and corporations to pay fairer wages and more taxes than their American counterparts currently do. Nordic citizens generally pay more taxes, too. And yes, this might sound scandalous in the United States, where business leaders and economists perpetually warn that tax increases would slow growth and reduce incentives to invest.

Here’s the funny thing, though: Over the past 50 years, if you had invested in a basket of Nordic equities, you would have earned a higher annual real return than the American stock market during the same half-century, according to global equities data published by Credit Suisse.

Nordic capitalists are not dumb. They know that they will still earn very handsome financial returns even after paying their taxes. They keep enough of their profits to live in luxury, wield influence and acquire social status. There are several dozen Nordic billionaires. Nordic citizens are not dumb, either. If you’re a member of the robust middle class in Finland, you generally get a better overall deal for your combined taxes and personal expenditures, as well as higher-quality outcomes, than your American counterparts — and with far less hassle.

Why would the wealthy in Nordic countries go along with this? Some Nordic capitalists actually believe in equality of opportunity and recognize the value of a society that invests in all of its people. But there is a more prosaic reason, too: Paying taxes is a convenient way for capitalists to outsource to the government the work of keeping workers healthy and educated.

While companies in the United States struggle to administer health plans and to find workers who are sufficiently educated, Nordic societies have demanded that their governments provide high-quality public services for all citizens. This liberates businesses to focus on what they do best: business. It’s convenient for everyone else, too. All Finnish residents, including manual laborers, legal immigrants, well-paid managers and wealthy families, benefit hugely from the same Finnish single-payer health care system and world-class public schools.

There’s a big lesson here: When capitalists perceive government as a logistical ally rather than an ideological foe and when all citizens have a stake in high-quality public institutions, it’s amazing how well government can get things done.

Ultimately, when we mislabel what goes on in Nordic nations as socialism, we blind ourselves to what the Nordic region really is: a laboratory where capitalists invest in long-term stability and human flourishing while maintaining healthy profits.

Capitalists in the United States have taken a different path. They’ve slashed taxes, weakened government, crushed unions and privatized essential services in the pursuit of excess profits. All of this leaves workers painfully vulnerable to capitalism’s dynamic disruptions. Even well-positioned Americans now struggle under debilitating pressures, and a majority inhabit a treacherous Wild West where poverty, homelessness, medical bankruptcy, addiction and incarceration can be just a bit of bad luck away. Americans are told that this is freedom and that it is the most heroic way to live. It’s the same message Finns were fed a century ago.

But is this approach the most effective or even the most profitable way for capitalists in the United States to do business? It should come as no surprise that resentment and fear have become rampant in the United States, and that President Trump got elected on a promise to turn the clock backward on globalization. Nor is it surprising that American workers are fighting back; the number of workers involved in strikes last year in the United States was the highest since the 1980s, and this year’s General Motors strike was the company’s longest in nearly 50 years. Nor should it surprise anyone that fully half of the rising generation of Americans, aged 18 to 29, according to Gallup polling, have a positive view of socialism.

The prospect of a future full of socialists seems finally to be getting the attention of some American business leaders. For years the venture capitalist Nick Hanauer has been warning his “fellow zillionaires” that “the pitchforks are coming for us.” Warren Buffett has been calling for higher taxes on the rich, and this year the hedge-fund billionaire Ray Dalio admitted that “capitalism basically is not working for the majority of people.” Peter Georgescu, chairman emeritus of Young & Rubicam, has put it perhaps most succinctly: He sees capitalism “slowly committing suicide.”In recent months such concerns have spread throughout the capitalist establishment. The Financial Times rocked its business-friendly readership with a high-profile series admitting that capitalism has indeed become “rigged” and that it desperately needs a “reset,” to restore truly free markets and bring back real opportunity. Leading captains of finance and industry in the United States rocked the business world, too, with a joint declaration from the Business Roundtable that they will now prioritize not only profits but also “employees, customers, shareholders and the communities.” They are calling this “stakeholder capitalism.”

If these titans of industry are serious about finding a more sustainable approach, there’s no need to reinvent the wheel. They can simply consult their Nordic counterparts. If they do, they might realize that the success of Nordic capitalism is not due to businesses doing more to help communities. In a way, it’s the opposite: Nordic capitalists do less. What Nordic businesses do is focus on business — including good-faith negotiations with their unions — while letting citizens vote for politicians who use government to deliver a set of robust universal public services.

This, in fact, may be closer to what a majority of people in the United States actually want, at least according to a poll released by the Pew Research Center this year. Respondents said that the American government should spend more on health care and education, for example, to improve the quality of life for future generations.

But the poll also revealed that Americans feel deeply pessimistic about the nation’s future and fear that worse political conflict is coming. Some military analysts and historians agree and put the odds of a civil war breaking out in the United States frighteningly high.

Right now might be an opportune moment for American capitalists to pause and ask themselves what kind of long-term cost-benefit calculation makes the most sense. Business leaders focused on the long game could do a lot worse than starting with a fact-finding trip to Finland.

Here in Helsinki, our family is facing our second Nordic winter and the notorious darkness it brings. Our Finnish friends keep asking how we handled the first one and whether we can survive another. Our answer is always the same. As we push our 2-year-old daughter in her stroller through the dismal, icy streets to her wonderful, affordable day-care center or to our friendly, professional and completely free pediatric health center, before heading to work in an innovative economy where a vast majority of people have a decent quality of life, the winter doesn’t matter one bit. It can actually make you happy.

“…We find it noteworthy that the best-fitting model for empirical wealth distribution discovered so far is one that would be completely unstable without redistribution rather than one based on a supposed equilibrium of market forces. In fact, these mathematical models demonstrate that far from wealth trickling down to the poor, the natural inclination of wealth is to flow upward, so that the “natural” wealth distribution in a free-market economy is one of complete oligarchy.It is only redistribution that sets limits on inequality. The mathematical models also call attention to the enormous extent to which wealth distribution is caused by symmetry breaking, chance and early advantage (from, for example, inheritance). And the presence of symmetry breaking puts paid to arguments for the justness of wealth inequality that appeal to “voluntariness”—the notion that individuals bear all responsibility for their economic outcomes simply because they enter into transactions voluntarily—or to the idea that wealth accumulation must be the result of cleverness and industriousness. It is true that an individual's location on the wealth spectrum correlates to some extent with such attributes, but the overall shape of that spectrum can be explained to better than 0.33 percent by a statistical model that completely ignores them. Luck plays a much more important role than it is usually accorded, so that the virtue commonly attributed to wealth in modern society—and, likewise, the stigma attributed to poverty—is completely unjustified….”

Bruce Boghosian, "Is Inequality Inevitable?"Scientific American,November 1, 2019, https://www.scientificamerican.com/article/is-inequality-inevitable/

Is Inequality Inevitable?

Wealth inequality is escalating in many countries at an alarming rate, with the U.S. arguably having the highest inequality in the developed world.
A remarkably simple model of wealth distribution developed by physicists and mathematicians can reproduce inequality in a range of countries with unprecedented accuracy.
Surprisingly, several mathematical models of free-market economies display features of complex macroscopic physical systems such as ferromagnets, including phase transitions, symmetry breaking and duality.

Wealth inequality is escalating at an alarming rate not only within the U.S. but also in countries as diverse as Russia, India and Brazil. According to investment bank Credit Suisse, the fraction of global household wealth held by the richest 1 percent of the world's population increased from 42.5 to 47.2 percent between the financial crisis of 2008 and 2018. To put it another way, as of 2010, 388 individuals possessed as much household wealth as the lower half of the world's population combined—about 3.5 billion people; today Oxfam estimates that number as 26. Statistics from almost all nations that measure wealth in their household surveys indicate that it is becoming increasingly concentrated.

Although the origins of inequality are hotly debated, an approach developed by physicists and mathematicians, including my group at Tufts University, suggests they have long been hiding in plain sight—in a well-known quirk of arithmetic. This method uses models of wealth distribution collectively known as agent-based, which begin with an individual transaction between two “agents” or actors, each trying to optimize his or her own financial outcome. In the modern world, nothing could seem more fair or natural than two people deciding to exchange goods, agreeing on a price and shaking hands. Indeed, the seeming stability of an economic system arising from this balance of supply and demand among individual actors is regarded as a pinnacle of Enlightenment thinking—to the extent that many people have come to conflate the free market with the notion of freedom itself. Our deceptively simple mathematical models, which are based on voluntary transactions, suggest, however, that it is time for a serious reexamination of this idea.

In particular, the affine wealth model (called thus because of its mathematical properties) can describe wealth distribution among households in diverse developed countries with exquisite precision while revealing a subtle asymmetry that tends to concentrate wealth. We believe that this purely analytical approach, which resembles an x-ray in that it is used not so much to represent the messiness of the real world as to strip it away and reveal the underlying skeleton, provides deep insight into the forces acting to increase poverty and inequality today.

OLIGARCHY

In 1986 social scientist John Angle first described the movement and distribution of wealth as arising from pairwise transactions among a collection of “economic agents,” which could be individuals, households, companies, funds or other entities. By the turn of the century physicists Slava Ispolatov, Pavel L. Krapivsky and Sidney Redner, then all working together at Boston University, as well as Adrian Drgulescu, now at Constellation Energy Group, and Victor Yakovenko of the University of Maryland, had demonstrated that these agent-based models could be analyzed with the tools of statistical physics, leading to rapid advances in our understanding of their behavior. As it turns out, many such models find wealth moving inexorably from one agent to another—even if they are based on fair exchanges between equal actors. In 2002 Anirban Chakraborti, then at the Saha Institute of Nuclear Physics in Kolkata, India, introduced what came to be known as the yard sale model, called thus because it has certain features of real one-on-one economic transactions. He also used numerical simulations to demonstrate that it inexorably concentrated wealth, resulting in oligarchy.

You might construct two arguments, both rather persuasive, to help you decide what to do. You may think, “I have a probability of ½ of gaining $20 and a probability of ½ of losing $17. My expected gain is therefore:

½ x ($20) + ½ x (-$17) = $1.50

which is positive. In other words, my odds of winning and losing are even, but my gain if I win will be greater than my loss if I lose.” From this perspective it seems advantageous to play this game.

Or, like a chess player, you might think further: “What if I stay for 10 flips of the coin? A likely outcome is that five of them will come up heads and that the other five will come up tails. Each time heads comes up, my ante is multiplied by 1.2. Each time tails comes up, my ante is multiplied by 0.83. After five wins and five losses in any order, the amount of money remaining on the table will be:

1.2 x 1.2 x 1.2 x 1.2 x 1.2 x 0.83 x 0.83 x 0.83 x 0.83 x 0.83 x $100 = $98.02

so I will have lost about $2 of my original $100 ante.” With a bit more work you can confirm that it would take about 93 wins to compensate for 91 losses. From this perspective it seems disadvantageous to play this game.

The contradiction between the two arguments presented here may seem surprising at first, but it is well known in probability and finance. Its connection with wealth inequality is less familiar, however. To extend the casino metaphor to the movement of wealth in an (exceedingly simplified) economy, let us imagine a system of 1,000 individuals who engage in pairwise exchanges with one another. Let each begin with some initial wealth, which could be exactly equal. Choose two agents at random and have them transact, then do the same with another two, and so on. In other words, this model assumes sequential transactions between randomly chosen pairs of agents. Our plan is to conduct millions or billions of such transactions in our population of 1,000 and see how the wealth ultimately gets distributed.

What should a single transaction between a pair of agents look like? People have a natural aversion to going broke, so we assume that the amount at stake, which we call Δω (Δω is pronounced “delta w”), is a mere fraction of the wealth of the poorer person, Shauna. That way, even if Shauna loses in a transaction with Eric, the richer person, the amount she loses is always less than her own total wealth. This is not an unreasonable assumption and in fact captures a self-imposed limitation that most people instinctively observe in their economic life. To begin with—just because these numbers are familiar to us—let us suppose Δω is 20 percent of Shauna's wealth, ω, if she wins and -17 percent of ω if she loses. (Our actual model assumes that the win and loss percentages are equal, but the general outcome still holds. Moreover, increasing or decreasing Δω will just extend the time scale so that more transactions will be required before we can see the ultimate result, which will remain unaltered.)

If our goal is to model a fair and stable market economy, we ought to begin by assuming that nobody has an advantage of any kind, so let us decide the direction in which w is moved by the flip of a fair coin. If the coin comes up heads, Shauna gets 20 percent of her wealth from Eric; if the coin comes up tails, she must give 17 percent of it to Eric. Now randomly choose another pair of agents from the total of 1,000 and do it again. In fact, go ahead and do this a million times or a billion times. What happens?

If you simulate this economy, a variant of the yard sale model, you will get a remarkable result: after a large number of transactions, one agent ends up as an “oligarch” holding practically all the wealth of the economy, and the other 999 end up with virtually nothing. It does not matter how much wealth people started with. It does not matter that all the coin flips were absolutely fair. It does not matter that the poorer agent's expected outcome was positive in each transaction, whereas that of the richer agent was negative. Any single agent in this economy could have become the oligarch—in fact, all had equal odds if they began with equal wealth. In that sense, there was equality of opportunity. But only one of them did become the oligarch, and all the others saw their average wealth decrease toward zero as they conducted more and more transactions. To add insult to injury, the lower someone's wealth ranking, the faster the decrease.

This outcome is especially surprising because it holds even if all the agents started off with identical wealth and were treated symmetrically. Physicists describe phenomena of this kind as “symmetry breaking”. The very first coin flip transfers money from one agent to another, setting up an imbalance between the two. And once we have some variance in wealth, however minute, succeeding transactions will systematically move a “trickle” of wealth upward from poorer agents to richer ones, amplifying inequality until the system reaches a state of oligarchy.

If the economy is unequal to begin with, the poorest agent's wealth will probably decrease the fastest. Where does it go? It must go to wealthier agents because there are no poorer agents. Things are not much better for the second-poorest agent. In the long run, all participants in this economy except for the very richest one will see their wealth decay exponentially. In separate papers in 2015 my colleagues and I at Tufts University and Christophe Chorro of Université Panthéon-Sorbonne provided mathematical proofs of the outcome that Chakraborti's simulations had uncovered—that the yard sale model moves wealth inexorably from one side to the other.

Does this mean that poorer agents never win or that richer agents never lose? Certainly not. Once again, the setup resembles a casino—you win some and you lose some, but the longer you stay in the casino, the more likely you are to lose. The free market is essentially a casino that you can never leave. When the trickle of wealth described earlier, flowing from poor to rich in each transaction, is multiplied by 7.7 billion people in the world conducting countless transactions every year, the trickle becomes a torrent. Inequality inevitably grows more pronounced because of the collective effects of enormous numbers of seemingly innocuous but subtly biased transactions.

THE CONDENSATION OF WEALTH

You might, of course, wonder how this model, even if mathematically accurate, has anything to do with reality. After all, it describes an entirely unstable economy that inevitably degenerates to complete oligarchy, and there are no complete oligarchies in the world. It is true that, by itself, the yard sale model is unable to explain empirical wealth distributions. To address this deficiency, my group has refined it in three ways to make it more realistic.

In 2017 Adrian Devitt-Lee, Merek Johnson, Jie Li, Jeremy Marcq, Hongyan Wang and I, all at Tufts, incorporated the redistribution of wealth. In keeping with the simplicity desirable in applied mathematics models, we did this by having each agent take a step toward the mean wealth in the society after each transaction. The size of the step was some fraction χ (or “chi”) of his or her distance from the mean. This is equivalent to a flat wealth tax for the wealthy (with tax rate χ per unit time) and a complementary subsidy for the poor. In effect, it transfers wealth from those above the mean to those below it. We found that this simple modification stabilized the wealth distribution so that oligarchy no longer resulted. And astonishingly, it enabled our model to match empirical data on U.S. and European wealth distribution between 1989 and 2016 to better than 2 percent. The single parameter χ seems to subsume a host of real-world taxes and subsidies that would be too messy to include separately in a skeletal model such as this one.

The inclusion of wealth-related bias also yields—and gives a precise mathematical definition to—the phenomenon of partial oligarchy. Whenever the influence of wealth-attained advantage exceeds that of redistribution (more precisely, whenever ζ exceeds χ), a vanishingly small fraction of people will possess a finite fraction, 1 − χ/ζ, of societal wealth. The onset of partial oligarchy is in fact a phase transition for another model of economic transactions, as first described in 2000 by physicists Jean-Philippe Bouchaud, now at École Polytechnique, and Marc Mézard of the École Normale Supérieure. In our model, when ζ is less than χ, the system has only one stable state with no oligarchy; when ζ exceeds χ, a new, oligarchical state appears and becomes the stable state. The two-parameter (χ and ζ) extended yard sale model thus obtained can match empirical data on U.S. and European wealth distribution between 1989 and 2016 to within 1 to 2 percent.

Such a phase transition may have played a crucial role in the condensation of wealth following the breakup of the Soviet Union in 1991. The imposition of what was called shock therapy economics on the former states of the U.S.S.R. resulted in a dramatic decrease of wealth redistribution (that is, decreasing χ) by their governments and a concomitant jump in wealth-attained advantage (increasing ζ) from the combined effects of sudden privatization and deregulation. The resulting decrease of the “temperature” χ/ζ threw the countries into a wealth-condensed state, so that formerly communist countries became partial oligarchies almost overnight. To the present day at least 10 of the 15 former Soviet republics can be accurately described as oligarchies.

As a third refinement, in 2019 we included negative wealth—one of the more disturbing aspects of modern economies—in our model. In 2016, for example, approximately 10.5 percent of the U.S. population was in net debt because of mortgages, student loans and other factors. So we introduced a third parameter, κ (or “kappa”), which shifts the wealth distribution downward, thereby accounting for negative wealth. We supposed that the least wealth the poorest agent could have at any time was -S, where S equals κ times the mean wealth. Prior to each transaction, we loaned wealth S to both agents so that each had positive wealth. They then transacted according to the extended yard sale model, described earlier, after which they both repaid their debt of S.

The three-parameter (χ, ζ, κ) model thus obtained, called the affine wealth model, can match empirical data on U.S. wealth distribution to less than a sixth of a percent over a span of three decades. (In mathematics, the word “affine” describes something that scales multiplicatively and translates additively. In this case, some features of the model, such as the value of Δω, scale multiplicatively with the wealth of the agent, whereas other features, such as the addition or subtraction of S, are additive translations or displacements in “wealth space.”) Agreement with European wealth-distribution data for 2010 is typically better than a third to a half of a percent.

To obtain these comparisons with actual data, we had to solve the “inverse problem.” That is, given the empirical wealth distribution, we had to find the values of (χ, ζ, κ) at which the results of our model most closely matched it. As just one example, the 2016 U.S. household wealth distribution is best described as having χ = 0.036, ζ = 0.050 and κ = 0.058. The affine wealth model has been applied to empirical data from many countries and epochs. To the best of our knowledge, it describes wealth-distribution data more accurately than any other existing model.

We find it noteworthy that the best-fitting model for empirical wealth distribution discovered so far is one that would be completely unstable without redistribution rather than one based on a supposed equilibrium of market forces. In fact, these mathematical models demonstrate that far from wealth trickling down to the poor, the natural inclination of wealth is to flow upward, so that the “natural” wealth distribution in a free-market economy is one of complete oligarchy. It is only redistribution that sets limits on inequality.

The mathematical models also call attention to the enormous extent to which wealth distribution is caused by symmetry breaking, chance and early advantage (from, for example, inheritance). And the presence of symmetry breaking puts paid to arguments for the justness of wealth inequality that appeal to “voluntariness”—the notion that individuals bear all responsibility for their economic outcomes simply because they enter into transactions voluntarily—or to the idea that wealth accumulation must be the result of cleverness and industriousness. It is true that an individual's location on the wealth spectrum correlates to some extent with such attributes, but the overall shape of that spectrum can be explained to better than 0.33 percent by a statistical model that completely ignores them. Luck plays a much more important role than it is usually accorded, so that the virtue commonly attributed to wealth in modern society—and, likewise, the stigma attributed to poverty—is completely unjustified.

Moreover, only a carefully designed mechanism for redistribution can compensate for the natural tendency of wealth to flow from the poor to the rich in a market economy. Redistribution is often confused with taxes, but the two concepts ought to be kept quite separate. Taxes flow from people to their governments to finance those governments' activities. Redistribution, in contrast, may be implemented by governments, but it is best thought of as a flow of wealth from people to people to compensate for the unfairness inherent in market economics. In a flat redistribution scheme, all those possessing wealth below the mean would receive net funds, whereas those above the mean would pay. And precisely because current levels of inequality are so extreme, far more people would receive than would pay.

Given how complicated real economies are, we find it gratifying that a simple analytical approach developed by physicists and mathematicians describes the actual wealth distributions of multiple nations with unprecedented precision and accuracy. Also rather curious is that these distributions display subtle but key features of complex physical systems. Most important, however, the fact that a sketch of the free market as simple and plausible as the affine wealth model gives rise to economies that are anything but free and fair should be both a cause for alarm and a call for action.

Research that mirrorsMcKinsey'swork on superstar cities and Simon Johnson recentbookfinds that "innovation industries" (defined here sectors whose R&D expenditures exceed $20,000 per worker and have a STEM-worker share of 45%) growth has increasingly consolidated in just five metro areas, four of which are on the west coast (Boston, San Francisco, San Jose, Seattle, and San Diego). 90% of the nation’s innovation-sector growth during the years 2005 to 2017 took place in these five regions, in contrasts the bottom 90% of metro areas (343 regions) lost share. The net result is one-third of innovation jobs now reside in 16 counties, and more than half are concentrated in 41 counties.

Note they note that Simon Johnson would accept "hypothetical" reductions in the efficiency of R&D spending in exchange for re-balancing regional economic gains, "...Similarly, Gruber and Johnson would accept a “hypothetical” reduction in the efficiency of R&D spending in exchange for a national campaign to expand the pipeline of new ideas and concomitant regional economic gains. They urge a “big push” to spread federal R&D dollars “wider than the existing superstar cities to which they flow today,” albeit to places where they can nevertheless be employed productively...."

Robert Atkinson, Mark Muro and Jacob Whiton, "The Case for Growth Centers: How to spread tech innovation across America," Brookings and Information and Technology & Innovation Foundation, December 2019, https://www.brookings.edu/wp-content/uploads/2019/12/Full-Report-Growth-Centers_PDF_BrookingsMetro-BassCenter-ITIF.pdf

"....The innovation sector... encompass America’s 13 highest tech, highest-R&D industries. Selected from among the 50 advanced industries, the 13 innovation industries represent a cohort whose R&D expenditures exceed $20,000 per worker and have a STEM-worker share of 45%.....—comprised of 13 of the nation’s highest-tech, highest-R&D “advanced” industries—contributes inordinately to regional and U.S. prosperity. Its diffusion into new places would greatly benefit the nation’s well-being. However, far from diffusing, the sector has been concentrating in a short list of superstar metropolitan areas. Most notably, just five top innovation metro areas—Boston, San Francisco, San Jose, Seattle, and San Diego—accounted for more than 90% of the nation’s innovation-sector growth during the years 2005 to 2017. In this fashion, they have increased their share of the nation’s total innovation employment from 17.6% to 22.8% since 2005. In contrast, the bottom 90% of metro areas (343 of them) lost share..... Fully one-third of the nation’s innovation jobs now reside in just 16 counties, and more than half are concentrated in 41 counties....."

Note attached WSJ and Porter in NYT reporting on the research.

New NBER looks at the effect of immigration restrictions in the United States during the 1920's and finds that a) wages for us workers in areas receiving fewer immigrants did not rise. b) US workers responded by moving to (higher productivity presumably) urban areas replacing European immigrants and drove down native wages in urban areas c) farmers responded to higher labor cost by shifting towards more capital intensive agriculture. The writers suggests that the American experience during the 1920's implies that restrictions on immigration will result in sustainability such as automation and off-shoring before wages climb.

Effects A and B, areas getting fewer immigration did not see wages rise, and wages fell in urban areas as higher skilled labor moved in (which implies immigrants had been sedating wages)"....In the United States, the era of open immigration with Europe ended abruptly in the 1920s. A series of restrictive acts introduced immigration quotas that were particularly targeted at immigrants from Southern and Eastern Europe. The quotas effectively limited the annual number of immigrants admitted to the United States by more than 75 percent. Given the substantial reduction of immigrant labor, a simple model would predict that wages for the existing workforce would increase. Yet, we find that the occupation-based earnings of US-born workers in labor markets exposed to the quota policy fell after the border closure.We then document how the economy adjusted to the decline in immigrant workers to explain this puzzling result. Once the immigrant flow into US cities declined, US-born workers and unrestricted immigrants from Mexico and Canada started entering in larger numbers, replacing the immigrant workers at a nearly one-to-one rate. The new arrivals into cities were more skilled, on average, than the immigrants that they replaced, making them closer substitutes to the existing US-born workers...We find that workers who were unrestricted by the quota policy (i.e., US-born workers and immigrants from the Western Hemisphere, including Mexicans and Canadians) replaced the loss of immigrant labor in exposed urban areas nearly one-for-one after the border closure. These new arrivals were more skilled than the immigrants that they replaced, filling only 50 percent of low-skilled blue collar positions previously held by immigrants. The arrival of higher skilled artisans and tradesmen, who may have been closer substitutes for existing US-born workers than the immigrant workers they replaced, can help explain why the earnings of existing residents fell after the border closure...."

Effect C, shift to capital intensive agriculture, "... By contrast, in rural areas, the loss of immigrant workers encouraged land owners to invest in more farm capital and to shift away from labor-intensive crops, which in turn discouraged US-born workers from moving into affected rural areas. We emphasize that our estimates reveal the total effect of the immigration restriction policy for local labor markets after corresponding flows of labor and capital occurred. Thus, the “puzzle” of why the earnings of US-born workers fell in cities after the border closure, despite a decline in immigrant labor supply, can be understood as the combined effect of a decline in the (primarily low-skilled) immigrant workforce and a corresponding rise in (a more mixed-skill) US-born workforce....Table 8 provides suggestive evidence that farmers adapted to the loss of immigrant farm labor by shifting into more capital-intensive production, thereby reducing employment opportunities for domestic workers as well. We measure the share of cultivated land planted in labor-intensive (hay and corn) versus capital-intensive (wheat) cereals... We find that rural areas with more quota exposure were more likely to plant capital-intensive wheat and less likely to plant labor-intensive cereals after the policy. Farmers also shift away from the use of draft animals (horses and mules), which are direct substitutes for new gasoline-powered tractor technology. Consistent with a decline in the demand for farm labor, farm wages decline by around 3 percent after the border closure for a one percentage point shift in quota exposure. However, we see no effect of the shift away from laborintensive production on average farm values indicating that the quota system did not impede the profitability of farming....."

Ran Abramitzky, Philipp Ager, Leah Platt Boustan, Elior Cohen, Casper Hansen, "The Effects of Immigration on the Economy: Lessons from the 1920s Border Closure," National Bureau of Economic Research, December 2019, https://www.nber.org/papers/w26536

Implications, "... It is rare to find such drastic changes in immigration policy and so this historical episode has important lessons for contemporary policy. Substantially walling off the US economy to new immigration did open up some employment opportunities for US-born workers who moved to urban areas to take jobs previously held by immigrant workers. However, using immigration restriction to raise the earnings of US-born workers more broadly is unlikely to be effective given the many factors that can substitute for immigrant workers. In the early twentieth century, restricting immigration from Europe encouraged labor flows from Mexico and Canada into urban areas, and the investment in new capital in rural areas. Today, these sources of substitutability may be automation in the manufacturing sector or the off-shoring of high-skilled tasks like computer programming or legal services....."

Burkhauser uses a Full-Income Poverty Measure and finds that poverty rate based on President Johnson’s standards fell from 19.5 percent in 1963 to 2.3 percent in 2017. His FPMis “..matches President Johnson’s initial standard. Second,these initial 1963 thresholds must be held constant in real terms over time by updating them each year using an unbiased measure of inflation. Third, the metric for evaluating success should include the full array of anti-poverty programs utilized by the government, including in-kind transfers and transfers administered through the tax code. No existing poverty measure meets all three of these conditions. We create a poverty measure, which we refer to as the Full-Income Poverty Measure (FPM), which meets all three of these conditions…”

"... Based on our FPM, we find that the poverty rate fell from 19.5 percent in 1963 to 2.3 percent in 2017, suggesting that President Johnson’s War on Poverty as he defined it based on absolute 1960s living standards is largely over and a success.That should not be surprising in light of substantial improvements in full-income throughout the distribution and the creation and expansion of major safety net programs, with median income more than doubling between 1963 and 2017. It also would not have been surprising to President Johnson and his advisers, including Robert Lampman who predicted in 1971 that poverty based on these initial standards would be eliminated by 1980. The dramatic reduction in poverty by 2017 based on President Johnson’s standards suggests that policymakers should consider setting new poverty thresholds that reflect modern-day expectations for what it means to be impoverished. For example, one could consider the current 12.3 percent poverty rate under the OPM to be the appropriate poverty rate based on today’s living standards. But even if today’s standards are preferred, this should not discount the progress made in reducing poverty over the past half-century. Under this approach, Figure 9 shows a version of the FPM that is anchored to the 12.3 percent poverty rate under the OPM in 2017. By this standard, the poverty rate under the FPM fell from 66.2 percent in 1963 to 12.3 percent in 2017. Thus, 54 percent of the U.S. population has been lifted from poverty since 1963 based on this modern poverty standard. Hence, even if policymakers reconsider the standards for poverty, it will still be true that poverty using an absolute standard is far below where it stood in the 1960s at the start of President Johnson’s War on Poverty...."