On the dynamics of wealth inequality

5 October, 2015 at 11:19 | Posted in Economics | Leave a comment

Over the last three decades, Atkinson et al. (2011) find that there has been an increase in the concentration of income in many countries while Wolff (2010) describes a similar though smaller increase in the concentration of wealth in the United States.

the-truth-about-wealth-inequalityMotivated by these stylized facts, we develop a model in which infinitely lived households face idiosyncratic investment risk, and we examine the dynamic behavior of the distribution of wealth over time. Our goal is to explore these dynamics in the absence of any redistributive mechanisms, so that the outcome of the model is affected only by households׳ optimal decisions about how much to consume or save and their realized labor and investment incomes. Because we assume that all households are equally patient and have identical abilities, it is luck alone—in the form of high realized investment returns—that creates diverging levels of wealth. In this setting, we show that the equilibrium distribution of wealth is not stationary, and, using recent results in mathematical finance and stochastic portfolio theory, we prove that it becomes increasingly right-skewed over time and tends to a limit in which wealth is concentrated entirely at the top …

The main conclusion of our analysis is clear. In the absence of any redistribution, the distribution of wealth is unstable over time and grows increasingly right-skewed until virtually all wealth is concentrated with a single household. This occurs despite the fact that the households in the economy have identical opportunities and identical preferences and abilities. It is important to emphasize that our setup in this paper, in which there is absolutely no redistribution, is intended to describe an important benchmark case rather than to capture the true state of the World … In reality, a number of potentially redistributive mechanisms, such as government tax and fiscal policies and limited intergenerational transfers, constantly affect the economy and influence the extent of concentration of wealth at the top. Indeed, our conclusions highlight the importance of these redistributive mechanisms, since it is their presence alone that ensures the stability of the economy and prevents an outcome in which the distribution of wealth is non-stationary and grows increasingly right-skewed over time.

Ricardo Fernholz & Robert Fernholz

Given their rather arbitrary distributional assumptions, this kind of inequality dynamics models can basically never be anything but “thought experiments” — but they are still interesting because they show that even if people were the same in terms of efficiency, skilfulness, capability, etc., pure luck (randomness) may create a very unequal society where almost all wealth is concentrated to those at the top. This of course also gives an extra rational for building a society with strong redistributive institutions and mechanisms. Without a conscious effort to counteract the inevitable forces driving our societies towards an extreme income and wealth inequality, our societies crackle. It is crucial to have strong redistributive policies if we want to have stable economies and societies. Redistributive taxes and active fiscal policies are necessary ingredients for building a  good society.

What we see happen in the US, the UK, Sweden, and elsewhere, is deeply disturbing. The rising inequality is outrageous – not the least since it has to a large extent to do with income and wealth increasingly being concentrated in the hands of a very small and privileged elite.

Societies where we allow the inequality of incomes and wealth to increase without bounds, sooner or later implode. The cement that keeps us together erodes and in the end we are only left with people dipped in the ice cold water of egoism and greed. It’s high time to put an end to this the worst Juggernaut of our time!

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