Markets

How Perfect Markets Concentrate Wealth and Strangle Growth and Prosperity

The winners have us all playing a loser’s game

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By Steve Roth

Capitalism concentrates wealth. Ridicule Marx and his latter-day disciples all you like (I’ll help); he definitely got that right.

But capitalism is a big word with lots of meanings, and enough ideological baggage to fill a Lear Jet. Let’s talk about something more precise: perfect markets, with ownership, in which individuals compete with others to produce stuff, and store up savings. You can see this kind of perfect world in agent-based simulations like Sugarscape. Start with a bunch of sugar farmers trying to accumulate sugar in an artificial world, hit Go, and watch what happens.

Here’s what happens to wealth concentration (number of poorer farmers on the left, richer on the right):

Screen Shot 2016-06-04 at 8.14.52 PM

Wealth is pretty evenly distributed at the beginning (top). That doesn’t last long. You can see the same effect in another Sugarscape run, here compared to real-world wealth distributions:

Screen Shot 2016-06-04 at 7.28.09 AM

That’s the Gini coefficient for wealth. Zero equals perfect equality; everyone has equal wealth. 1.0 equals perfect inequality; one person has all the wealth.

Perfect markets concentrate wealth. It’s their nature. But at some point, market-generated wealth concentration strangles those very markets (compared to markets with broader distributions of wealth). If a handful of people have all the wealth, how many iPhones will Apple sell? If only a few have the wealth to buy cars, automakers will produce a handful of million-dollar Bugattis, instead of forty handfuls of $25,000 Toyotas. Sounding familiar?

But wealth concentration doesn’t just strangle the flows of spending, production, and income. It throttles the accumulation of wealth itself. Another simple simulation of an expanding economy (details here) explains this:

Screen Shot 2016-06-04 at 10.49.29 AM

The dynamics are straightforward here: poorer people spend a larger percentage of their income than richer people. So if less money is transferred to richer people (or more to poorer people), there’s more spending — so producers produce more (incentives matter), there’s more surplus from production, more income, more wealth…rinse and repeat.

This picture says nothing about how the wealth transfers happen (favored tax rates on ownership income, transfers to poorer and older folks, free public schools, Wall Street predation, the list is endless). It just shows the results: As wealth is transferred up to the rich, on the left, and wealth concentration increases, our total wealth increases more slowly. When that transfer is extreme, even in this growing economy the poorer people end up with less wealth. (Note how the curves get steeper on the left.) As wealth concentration declines on the right, our total wealth increases faster, and poorer people’s wealth increases much faster. Note that richer people still get richer in most scenarios — it’s a growing economy, always delivering a surplus from production, and increasing wealth — just more slowly.

And that’s just talking dollars. If we start thinking about our collective “utility,” or well-being — the total of everybody’s well-being, all summed up — the effects of wealth concentration are even more profound. Because poorer people getting more does a lot more for their well-being than richer people getting more. (Likewise, even if the richer people actually lose some of their wealth, they’re not losing as much utility.)

Because: Declining marginal utility of wealth (or consumption, or whatever). This is one of those Econ 101 psychological truisms that seems to actually be true. The fourth ice-cream cone (or Bugatti, or iPhone) just doesn’t deliver as much utility as the first one. Plus, a Bugatti in one person’s hands doesn’t deliver as much utility as forty Toyotas in forty people’s hands. (Prattle on all you want about relative and revealed preferences; you won’t alter this reality.)

So if we were to re-work the chart above showing utility instead of dollars, you’d see far greater increases in utility on the right side, especially for poorer people. Widespread prosperity both causes and is greater prosperity.

Why, then, aren’t we spending our lives on the right side of this chart? It’s a total win-win, right? The answer is not far to find. Nassim Taleb shows with some impressive math (PDF) what’s also easy to see with some arithmetic on the back of an envelope: if a few richer people (who dominate our government, financial system, and economy) have the choice between making our collective pie bigger or just grabbing a bigger slice, grabbing the bigger slice is the hands-down winner.

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That’s why decades of Innovative Financial Engineering has served, mostly, not to efficiently allocate resources to efficient producers, improve productivity, or increase production. Rather, these fiendishly clever entrepreneurial inventions control who gets the income from production. You can guess who wins that game. Top wealth-holders would be nuts to play it any other way (if you go with economists’ definition of rationality…).

But for the rest of us, it’s a loser’s game — at least compared to the world we could be living in. If household incomes had increased along with GDP, productivity, and other economic-growth measures for the last two or four decades, a typical household would have tens of thousands of dollars more to spend each year — and much bigger stores of wealth to draw on. If you think that sounds like a thriving, prosperous society…you’re right.

To summarize: perfect markets, left to their own devices, concentrate wealth. Concentrated wealth results in less wealth, and far less collective well-being. (You’ll notice that I haven’t even mentioned fairness. It matters. But I’ll leave that to my gentle readers.)

This all leads one to wonder: how could we move ourselves into that happy world of rapidly increasing wealth and well-being on the right side of the graph? Hmmmm….

Cross-posted at Asymptosis.

2016 June 5


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  • Jose Guerrero

    The “capitalist” economic model doesn’t exist without these inequalities but for now it’s seems to be the best way to do things because not every country can even if they wanted to apply social and economic models like in Sweden, Denmark…. Also pretending that there is such a thing as perfect markets is only useful for your first year of your economics. Therefore talking about the “real world” while using P.C. model just doesn’t make sense.

  • Jan de Jonge

    You will certainly receive comments that when you applied your argument to the world population the reverse of what you describe for the developed countries has occurred.
    I want to focus on the developed countries. There you see the same thing in almost all countries, namely a strong decline of the share of labor income (labor income quote) in national income and a rise of capital income of the same magnitude. I think that the decline of trade unions and the rise of flexible work explains a lot of this development. At this moment unions in France are striking. One of the new labor negotiations regulations they fight against is that wage negotiations in the future will take place on the level of the enterprise. This is a new attempt to displace trade unions further.

  • John M Legge

    “Perfect market” is an economic term of art. I think that you have misused it. The outcomes that you describe wouldn’t happen in the mythical world inhabited by economists if the markets there were perfect. (See https://weapedagogy.wordpress.com/2016/05/26/the-keynesian-revolution-and-the-monetarist-counter-revolution/).
    The neoliberal/Washington consensus model is based on assumptions (mostly false) leading to axioms (logically impeccable) one of which is that a deregulated market will act like a “perfect” one. Once you assume away large companies and banks and deprive governments of executive authority you get the rising inequality and growing stagnation that you describe accurately in practice, but not in high economic theory.
    You, like Keynes, are operating in the real world; but remember, neoliberals and neoconservatives alike “create their own reality” and try to force the rest of us to live in it.

    • Haris Iasonas Haralabides

      Keynes was adamant in (one of his last letters) highlighting that state-based stimulation of the economy isn’t a panacea and should be used in moderation and under specific (only) premises. Everybody seems to forget about this part (probably because it isn’t very helpful in serving their sinister plans for statism and subsequent benefits for themselves).

      Moreover, the neoliberal model is probably the only model that is based on pure application and historical evidence whereas anything in the Marxist’s parenthesis remains wishful thinking and arbitrary assumptions.

      P.S. The depicted model here is a zero-sum game which is certainly NOT representative of macroeconomic dynamics especially in a globalised world.

      • John M Legge

        If you think that the neoliberal model is based on the real world you have succeeded in creating your own reality.

        • Haris Iasonas Haralabides

          You certainly need to understand that libertarian (which I presume is what you mean by the term “neoliberal”) ideology isn’t as absolute as you might think it is.

          Economies are always going to be hybrids anyway.

          What libertarians theorists advocate is that there is a relatively linear correlation between growth and freedom of operation of markets.

          They are not anarcho-capitalists.

          They acknowledge the role of the state as a regulator of society. It isn’t a purist ideology at all.

          Communism and socialism (not social-democratic schemes – which are hybrids) ARE purist ideologies, so in NationalSOCIALISM and fascism.

      • John M Legge

        If you are going to quote Keynes please give an accurate reference.

        • Haris Iasonas Haralabides

          Look into the last article he ever wrote. I think there’s a paper about it named “Keynes against the Keynsians” available in the internet.

          Moreover, Friedman mentions it in this YT video: https://www.youtube.com/watch?v=_9DH07MBG_w

          • John M Legge

            You may think that there is such a paper, but Google doesn’t. Friedman on Keynes is like the Devil on Mother Theresa.

          • Haris Iasonas Haralabides

            It’s a work by professor T.W. Hutchison. The title is “Keynes versus the Keynesians”, it’s available online and it looks into the concerns of J.M Keynes towards his “disciples”. Worth reading.

          • Haris Iasonas Haralabides

            P.S. Dr. Friedman may have been a lot of things but he was no liar.

  • Nicholas Gruen

    Steve,

    As I read Nassim Nicholas Taleb, he’s saying that, if the 1% or the 1% of the 1% choose between investing their lobbying efforts into grabbing hold of more rent or growing the pie, there’s more in it for them to do the latter.

    That makes the next paragraph you write beginning with the expression “That’s why” a non sequitur. It’s not very surprising that the blizzard of transactions engineered by the financial sector enrich the wealthy at the expense of those who are not, but it’s not demonstrated by Taleb.

    And while one wouldn’t want to conclude with the conclusions to which orthodox theory might lead, it surely is a good question to ask. Those who buy financial services from the finance sector do so to advantage themselves. So how come they don’t end up advantaging themselves, or if they do in individual transactions, they don’t in aggregate? Presumably asymmetric information is an important part of a story in which that is true, but it’s still quite a mystery as to how it’s all done.

    Note I think of finance as quite like medicine – a carnival of asymmetric information in which markets and the culture they tend to induce over time – in which people get ripped off by those further up the information chain who know more than they do – and often get suckered into buying more services than they need, or the wrong services. But finance is a bit different. People don’t need to buy it, like they often have to buy health services – for better or for worse, and in too many cases for worse!

  • chris goodwin

    Two things you say I find objectionable.

    Firstly, you talk about “capitalism” as though it exists, or has existed, or might ever exist. I see no evidence that this flight of fancy deserves a moments consideration.

    Secondly, you assume as axiomatic the desirability, let alone the possibility, of egalitarianism. This is idealism of the very purest, and therefore most ridiculous form. It assumes a static economy, wherein, by some magical means, (I discount possible, or political, or any pragmatic means, because none have ever been demonstrated to be effective,) “we” (for some value of “we”) can all be brought to the same state. This is possible only if we are all dead, when “Sceptre and Crown shall Tumble Down, and in the Dust be Equal Made with the Poor Crooked Scythe and Spade.” So maybe we should seek to promote, or provoke a really good, big War, to kill everyone. We have the Technology. Thence equality, by simultaneous loss of everything, by everybody.

    Otherwise people will immediately, continually, and quite naturally, rationally, and beneficially start to exchange some of the goods that have been (miraculously !) given to them – their “fair and equal” share of the world’s total supply of stuff, but which they do not want, know not how to use, have an allergic, or religious, or other objection to, away in exchange with others, who also have unwanted surplusses, but of the very “stuffs” that they lack.

    Have you never lived in the real world ? Have you never experienced rationing ? Do you not know what a black market it ? Do you think it is clever to join the police in chasing black marketeers ? Do you think that the Government, “In it’s infinite Wisdom” (as Alf Garnett would say,) can fairly – or equally – or justly – even assuming these terms are synonymous, which clearly they are not, – allocate scarce resources to all ? Or that any central authority can even remotely pretend to do better than a free market ?

    When the dam breaks, or the earthquake shatters half the buildings, killling vast chunks of the population, or a volcano erupts, or a tsunami strikes, or war devastates a city, then crude, clumsy emergency aid, rushed in by, say, the army, or the Red Cross, or similar, will be welcome. The help is basic, and minimal, and very welcome. Here’s a blanket for you , and a ladle full of broth for you , and a hunk of bread for you, and no, you cannot have any milk except for nursing mothers and babies, and I see you are a big man, who has to work hard digging in the wreckage, so maybe you get a slightly fuller ladel of soup, and you may get the bigger hunk of bread, and egalitarianism is moderated by instamt justice, of a kind. But this welcome help is justified only by emergency: it does not even begin to form the basis for a lasting social programmme – except for Stalinists.

    I begin to wonder what “Evonomics” is.

  • There is a difference in competition between companies supplying a more or less uniform commodity (sugar, crude oil), and those which supply much more differentiated goods (fashion) which complexity economics could emphasise more. In the former case one can imagine that the company which could produce at least cost could clean up the market. What would stop it doing so? Opacity in the market, geographical segmentation, competition law, political influence of others, competitors’ branding …? In the latter case, one can imagine that companies could more readily co-exist by finding different niches formed by varying consumer preferences.

    The idea that ‘perfect competition’, in the form of greater price and quality transparency, could lead to greater inequality has clear implications for the internet economy. As is obvious with Amazon, it’s straightforward for the lowest cost operator to wipe out the competition where a range of prices are instantly and clearly accessible. Similarly the sharing economy has potential to transfer a fair amount of market power to purchasers.

  • Duncan Cairncross

    Excellent

    Essentially a free even market with exactly equal players (as in the model) tends to concentrate wealth
    (interestingly it ends up with similar concentrations to the real world which implies that the “greater skills” of the rich are not important)

    And excessive wealth concentration slows down growth

    And this is all BEFORE any crony capitalism or the rich “buying the levers of power”

  • geonomist

    Like Confucius said, he who defines the terms, wins the argument. Stop bundling capitalism and market. Markets can’t exist without property. You need perfect property for a perfect market. Is your property perfect? Have you defined what’s yours, what’s mine, what’s ours? Do that, and take back the market from your opponents. Or host a yard sale. You’ll learn markets and get to know your neighbors.

  • Without accumulated capital, spending is useless–there is no productive capacity or the ability to produce it. You have a society with plenty of money and empty shelves. Spending does not drive the economy–investment and savings does. As a corollary, John Stuart Mill wrote, “Demand for commodities is not demand for labour.” Without capital labor cannot be employed productively.

  • Daniel McLaughlin

    Perfect markets are a silly sham. Markets are never and can never be perfect. They are dynamic, constantly changing, and unpredictable. The premise of the article is a straw man. Actual free markets are competitive markets, where the game changes all the time. The present protected, subsidized, and highly regulated markets are not free by any means. Current markets in most countries aren’t anything close to free or perfect markets these days, and much of the wealth concentration, as well as many of the other dysfunctions of society, have to do with politics, not market activities per se.

    • Haris Iasonas Haralabides

      Moreover the model here is a zero-sum based model (your loss – my gain) whereas real world economy is essentially a win-win situation. He who creates wealth is enlarging the “wealth pie” for all.

  • zack

    then how come there was never a monopoly observed under conditions of free competition as thomas dilorenzo research indicates? but every government regulation represents a cartel of those who can afford the new regulations or agree to the terms of the licensure. all the regulations are but tools of monopolization, something that wasnt happening in the market. and the government itself is nothing but a monopoly, so im seeing a contradiction here

  • Haris Iasonas Haralabides

    I am sorry but the model isn’t valid. It is a zero-sum model which has nothing to do with macroeconomic dynamics in a globalised world.

  • Haris Iasonas Haralabides

    Marx was insightful for the time frame and era he was alive. If he was to observe what happened in the decades after him, I suspect that he would have restructured his views.

    The equalising forces are basically supply and demand and the subsequent pricing formed ideally in an environment that is free of third-party distortion. Cartels cannot be formed in such an environment (imo elementary stuff).

    The concentration of wealth, that all statists love to point out, is the natural occurrence in the lives of people gifted with the talent of creation of wealth.

    I hope that most of us have realised by now that we can’t all be Warren Buffets since we aren’t good enough. Reality stares us in the eyes equally when we realise that Michael Jordan was probably a better player than all of us who played professionally basketball.

    Shall we apply Marx’s logic to individual talents (that make the world progress?). Are we to suppress all these natural or worked talents in the name of “equality”? Are we supposed to be equal by our creator? Why am I 6’10” and not sharing my height with others? If I was free to choose would I be inclined to share this attribute with others? Should I be coerced to do so by a higher authority?

    Is there a higher authority that possesses the wisdom to centrally plan and succeed in calculating all the chaotic consequences of such an action?

    These are obviously meant to be rhetoric questions and not ones that seek answers.

    In my view rich people became rich or are able to remain rich, because they understand something that others obviously don’t. They are naturally talented or have learned to be so in that respect. In either case there is a sound reason for this reality (by definition) and I feel is irrelevant with the rest of the conversation.

    Back to the economic part:

    Rich people increase the wealth pie FOR ALL (and ALL THE TIME – I may add).

    The logistics might favour them if viewed from a static perspective (as was the scoring report after every Chicago Bull game for MJ – but all his teammates, the sport and the world benefited from the existence of MJ).

    Lets examine an important aspect:

    Where do rich people keep their assets?

    Most of their wealth is (re)invested, consumed, placed in banks. In all of the above cases the public does or will (eventually) benefit.

    If the wealth is invested, it creates more places for employment, rises the value of companies (in the stock market or their general activity), it creates more wealth, which governments have to represent (roughly) by issuing more fiat currency that circulates for all (in the ways above),etc.

    The portion of the wealth that is consumed goes directly back to the pockets of others and government taxes who (as they claim) raise the standards of living for all (however, I seriously doubt that they do it in the most efficient way – that’s another talk).

    The portion of the wealth that is kept in banks benefits all those that want to create wealth themselves by getting loans from these financial institutes in order to materialise their own ideas, by the bank’s participation in investing schemes/funds (see investment part above), etc.

    In essence the whole of society benefits from participating in the aforementioned economic “grid”.

    Evidence that the latter is valid is depicted by the fact that worldwide poverty has been reduced, from a staggering 90% living below poverty line (just 200 years ago – a mere drop in the timeframe of human existence in organised societies) to below 10% (normalised) as we speak.

    See:

    react-text: 3368 https://ourworldindata.org/world-poverty/ /react-text

    All in all economics shouldn’t be treated as a zero-sum game (your loss – my gain). Especially so on the macroeconomic level.

    P.S. The link about “Perfect markets” is based on a closed, zero-sum game model that is certainly not what worldwide economy is.

  • Steve, This is a very good piece, but I think you are missing something that is rather important, namely, the consequences of purchasing power being sustained as wealth and income becomes concentrated by way of increasing debt. The result is financial crises and secular stagnation. See: http://www.rweconomics.com/htm/WDCh3e.htm and http://rwEconomics.com/LTLGAD.htm