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Income inequality is simple math

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Simple math is a great way to understand a system’s behavior. I picked up this trick from Warren Buffett’s writing and speaking. Warren often figures out which mathematical elements drive behavior of a stock or industry, and then uses that to set a boundary on his investment decisions. He gave a great analysis in February 2000 of why the first internet bubble had to pop. Three weeks later, it did.

His analysis depended entirely on noting that valuations in the internet companies were assuming profit growth of 15%, while the economy as a whole was growing at 2.5%, and profits were remaining a constant share of the economy. As he put it, “mathematically, that relationship can not continue to hold. I don’t know what will collapse, I don’t know who the survivors will be—and there will be many of them—but I do know that eventually the house of cards will tumble. It has to.”

The Simple Math of Wealth Inequality

Thomas Pitteky’s new book about income inequality is apparently making a big splash. I haven’t read it, yet, but I’ve been told he is very sympathetic to my point of view. Here’s my analysis, before reading the book.

I’ve long held that the driver of wealth inequality is much simpler than policy, philosophy, or ideology. It’s simple mathematical fact, given our tax rates.

I finally ran some numbers.

Starting position: rich own 25%, everyone else, 75%
Overall tax rate on everyone else, 39% (25% federal + 14% FICA)
Overall tax rate on the Rich, 17% (mainly capital gains)
Assuming the Rich can get an average ROI of 15%, while everyone else 10%
(a reasonable assumption, given that the entire class of high risk/high return investments requires one to be an accredited investor. I.e., rich.)

With these assumptions, in 50 years (say, 1960 to 2010), the income distribution goes from rich 25%, everyone else 75% to rich 85%, everyone else 14%.

If we assume that both groups get equal returns on their money, rather than the rich getting higher returns, we still go from 25/75 to 48/51 in just 50 years

The Rich Get Richer, Purely By Virtue of Ownership

As long as the overall tax rate on the rich is lower than the overall tax rate on the poor, even independent of the range of investment opportunities available (and the rich also have enough money to have a portfolio of large-enough bets that a single winner will ultra-increase their net worth), the rich will eventually own everything.

This is independent of whether they work harder, whether they are more committed, whether they “create jobs,” or anything else. It’s purely based on their after-tax rates of return. (And as for them being job creators, note that to the extent that they can lay people off, their rates of return will increase. Hiring decreases it.)

I don’t understand why this simple mathematical fact never comes up in these discussions.

Even If The Rich Allocate Capital Poorly, They Still Win

If you run the numbers, it doesn’t matter if the rich get below-market returns. Berkshire Hathaway, Warren Buffett’s company, has only gotten market-level returns in recent years. But he’s still owning more of the economy than you are, every year.

The tax rate differential is high enough that Warren Buffett’s interest income still has a better after-tax return than you have on your entire income.

Is the very concept of work doomed?

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I just read an excellent article on XConomy by Wade Roush in which he asks the question: is technology destroying the very basis of our economy to offer employment? And assuming it is (as a thought experiment), what might we do to stop it?

First, read the article. Otherwise, my commentary won’t make much sense.

First of all, I found it fascinating that Finland and Sweden have lower taxes than the US, despite having much better social benefits. “What!?!?!?” you cry, “lower taxes? But they’re inefficient, evil socialists! It destroys the prevailing Capitalism is Best Ever narrative to say such a thing!!!”

Well, let’s take a look. My state tax is 6.25%, my Federal taxes are 33%, and my FICA taxes are 14%. Add those together and we discover that I’m paying 53% in taxes, which is about 18% MORE1 than the 45% tax rate Wade quotes for Finland and Sweden.” The big difference is that my tax dollars go mainly to private defense contractors, private insurance companies, and other private providers of services hired by the government.

What about motivation?

Wade correctly points out that such welfare states have a problem motivating people to work. But is this a problem? If the promise of industrialization is coming true—to wit, that technology will free us to pursue things that are personally meaningful rather than productive—then decreased motivation to work doesn’t seem like a huge problem.

Perhaps what we need to do is make work either voluntary, or a phase of life (say, ages 25-40), after which you can continue to work if you enjoy it and are challenged by it, otherwise you must go out and create artwork.

Warren Buffett hasn’t needed to work in any economic sense during my entire lifetime (and then some!). But he has done so, and even took on the stressful job of running Solomon Brothers. Why? Not because the money was the big incentive, but because challenge and meaning, and rescuing an institution was important to him.

This implied theory that people’s only motivation is money continues to mystify me in an age where the #1 complaint people have about their jobs is that their jobs are meaningless, paper-pushing wastes of time that are nothing more than an excuse for a paycheck.

Do any of Wade’s solutions work?

I think Wade’s option #8 is really the only viable one. Solutions like “grow our way out of it” don’t solve the underlying systemic problem. First of all, you can’t grow everything fast enough forever, so you end up in the same situation somewhere down the line. Secondly, those solutions still cling to the notion that the only legitimate way to get paid is by doing valuable work. But if the fundamental premise we’re up against is that machines are devaluing the work rapidly, then any solution that starts with the assumption that there’s enough valuable work for everyone is doomed to fail.

As for retraining, I just have to laugh. People already accumulate a lifetime’s worth of debt for their first education that will let them spend a decade to advance to a solid, mid-level, middle-class job. While I hear this meme tossed around a lot, I challenge anyone who claims it’s possible to quit their job and retrain in another unrelated job that gives them the equivalent income. (Must be unrelated because again, the premise is that the first job has been rendered economically less vaulable by technology. Thus, the replacement job must be substantially different.)

What do you think? If technology really has made a great many humans redundant for the first time in history, we’re in uncharted waters. Where do we go from here? Anywhere we want to. Where do we want to go from here?

  1. The math is a bit weird here. What I mean is that if I make $100 in the US, I pay 53% tax, leaving $47. Someone from Finland pays 45% tax, leaving $55. That’s 17.78% more than the Fins. Actually, to do this correctly would require looking at the different tax brackets and drawing a big graph of income ranges, etc. At the end of the day, however, it’s hard to argue that most middle class people pay much lower taxes in the U.S. If you factor in their need to pay for the services that Finland and Sweden provide nationally (e.g. health insurance, mortgage insurance, maternity leave, etc.), Americans definitely have lower take home pay to spend on non-essentials. ↩

Targeted Ads are the Worst of all Possible Worlds

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The justification used for the incredible invasions of privacy on the part of the internet marketers of the world is that they want to serve us “targeted” ads. Targeted ads are ads that relate to what we’re doing at the moment. Theoretically, if I’m having a discussion about how my child is dying from kidney failure, that’s exactly the moment when I’ll feet eternally grateful to be shown an ad for how to overcome that embarrassing middle aged male incontinence issue.

All joking aside, targeted ads seem worse to me than random ads, even aside from the privacy violations. I am online to get things done (sometimes work things, sometimes social). I am rarely online to buy things, and when I am, I know it.

A “targeted” ad has a much higher probability of successfully distracting me into a purchase experience and completely derailing what I’m trying to do. An untargeted ad, though distracting, is much easier to ignore and far less of a drain on my productivity.

Perhaps if I intrinsically valued purchasing things, I’d welcome targeted ads. But I don’t intrinsically value buying things.

So on the very rare occasions I’m in buying mode, targeted ads are a good thing. But in the rest of my life, which is 99% of the time, targeted ads are downright destructive.

Good businesspeople oppose free markets

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A friend on Facebook posted an article about New Jersey outlawing Tesla’s direct-to-consumer car sales. My friend was decrying how Gov. Christie is being anti-free-market. And I agree 100%.

From what I’ve been able to see, it’s pretty clear that the big conservative political donors hate free markets. What they love is whatever give them, personally, the ability to get more wealth. By “free market” they mean “don’t do anything that interferes with my personal ability to make money.” For example, the Koch brothers compete by using their money to alter laws so they win. They don’t compete by being better businessmen.

When it comes to competition, they hate it and undermine it at every opportunity, unless they’re the winner.

When it comes to level playing fields (supposedly the bedrock of markets), they hate it.

When it comes to producing the best product at the lowest cost, they hate it.

When it comes to contributing to the infrastructure they use freely that was funded by the public, they hate it.

Business People Should Loathe Competition

It’s a real education to go to business school and ask: how much of this education is devoted to finding ways to gain a market advantage without actually having to do a better job? The answer: most of it. It’s called “business strategy.” We teach our students how to be anti-competitive and anti-free-market, all in the name of free markets.

This works, however. It works because with the right playing field, pitting anti-free-market forces against each other results in more efficient companies through market selection of companies that are fundamentally better than other companies. This produces better ultimate outcomes for the consumers and society who created the markets to begin with.

But never miss the critical point: free markets work because the players are all trying to gain market advantage by doing a better job than each other. The players themselves are not striving to have a fair market, they’re striving to win and eliminate the competition (and thus the market).

It’s the job of government to make sure the playing field is level enough to keep enough market participants that the market continues to function. Players all want monopoly, government wants thriving market participation.

Mr. Christie’s error is that he’s acting as a businessman. That’s not his job. His job is to take care of all his constituents overall, not just the business ones.

Don’t accidentally say f**k you to your customers!

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T-mobile is using the tune of the song F**k You by Cee Lo Green in their latest radio ads. They apparently missed the part of psychology where people recall the words to songs. They sing about how you should switch to T-mobile, which doesn’t require a contract.

Their intent is for you to break up with your current carrier. But communication doesn’t work that way. When we communicate, our audience hears … whatever our audience hears. Anyone who’s ever said to their shmoopie, “would you please pick up your socks?” knows that an innocent question can be heard as an attack on someone’s entire identity1.

Here’s how communication really works: I get my audience to think “f**k you” by listening to a song whose tune makes those lyrics come to mind. Then the lyrics say “T-Mobile” over and over. When my audience hears is “f**k you, T-Mobile.” Over and over. I seriously doubt that was their intent.

When you’re designing ads, public speeches, or even just carrying on a conversation, pay attention to the words you use. Choose words carefully, so they have the greatest chance of unambiguously conveying just the message you want to come across. And if you’re talking to your shmoopie, the only safe words are “yes, dear.” Use them often.

  1. For those of you not yet in relationships, the question “would you please pick up your socks?” is heard as “You are an ignorant slob who doesn’t deserve to live.” A much better way to say the same thing is to say, “Shmoopie? I’m cleaning the apartment. Where would you like me to put your socks?” ↩

Efficiency Might Be Bad

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I’m a huge fan of system dynamics and the understanding of complex systems that has come from the field that Jay Forrester invented.

This is a superb article by the late Donella Meadows about the leverage points in complex systems, in ascending order of effectiveness.

Alas, most of the things we do to try to change our social and economic systems use only the least effective levers.

Tonight I’m especially struck by #9, delays in systems. Delays of information and material movement can throw a system into or out of sync in ways that utterly change the system’s characteristics.

For many years, we’ve been operating as a society under the implicit assumption that speed = efficiency. The faster things are, the fewer delays, the better off we are.

But this isn’t necessarily true. Increasing the efficiency of communication decreases the time between communication we have to understand and respond. We end up in reactive mode, rather than thoughtful mode. That’s one of the pernicious effects of email. Many people take action on email as it comes in, rather than taking action only on what’s important. That can make the difference between overload and achievement.

Removing communication delays also seems to reduce our tendency to prepare. When you can make changes to your presentation all the way until the night before it’s due, then you will. In prior years, when you had no choice but to finish early enough to send your slides to be duplicated, you actually had time you could then use to rehearse and concentrate on delivery, rather than on making last-minute changes.

Read the article. Let me know your thoughts, if you still have enough attention span to make it through, after all the years we’ve spent training ourselves to operate in a purely reactive—but oh, so efficient–mode.

http://www.thesolutionsjournal.com/node/419

Success Principles are Often Bull&%$# !

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I ran across an article purporting to give principles necessary for success. I don’t buy it. Popular culture is full of “how to be successful” advice that’s pure bunk. It’s mostly made up by salespeople, based on disproven sports mythology. “Work harder” is great advice if you’re trying to win an Olympic medal, but not if you’re trying to earn a lot of money.

I know many phenomenally successful people who violate the vast majority of these rules. I know many people who follow all these rules and have for decades, and aren’t much more successful than they were when they started.

But these rules make us feel good. We want to feel in control. So this list comforts us. When we succeed, it gives us a list of reasons why we deserve success. When we fail, it gives us an explanation. Better to believe “Bill Gates is successful and I’m not because he got up earlier” than it is to believe “I’m not successful because I just was born into the wrong circumstances and nothing I could do would have made a difference.”

What Really Makes (Financial) Success

Conspicuously missing from the list is what Andrew Carnegie called the most powerful business force in the world: compound interest.

To abstract that a bit, in my own experience, rent-seeking activities are vastly superior to hard work in getting ahead. It’s bizarre that we reward this so highly, since it’s the hard work that creates the value for which rent is being extracted. Indeed, Adam Smith considered rent-seeking to be the morally lowest form of economic activity.

And yet, most of my retirement savings comes from owning stock and letting it compound. The money I’ve made from actually doing work is only a small share of my IRA. It’s the investing income over time (the rent-seeking activities) that have been the most important.

Warren Buffett, the 3rd richest man in the world, made money solely through owning assets, not through doing work.

Bill Gates, the richest man, actually made his money through rent-seeking. We just never tell that side of the story. The reason Steve Jobs—who arguably put three entire industries on the map—didn’t die with a net worth of 10x Bill Gates is because Gates kept his stock and Jobs sold his. It was the rent-seeking decision to keep stock that made Bill rich, not the hard work he and his 20,000 employees did to make that stock valuable.

Living an Extraordinary Life

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Want an intriguing program to listen to this weekend?

I do what I do is because I’m deeply committed to helping people live their full potential, especially when they have world-changing dreams. My background in business, entrepreneurship, and cognitive psychology gives me a unique set of skills for helping people whose personal and organizational lives are deeply entertwined.

One of my favorite clients started our work together saying, “my life is quite good. I have a well-paying job that I enjoy, colleauges who support me, and a great circle of friends.”

“Then why are you here?” I asked him. 

He responded, “Because, I don’t want a good life. I want an extraordinary life.”

I was floored. That led to shiftng my emphasis from clients’ businesses to addressing their businesses and their lives.

Many years later, in 2012, I gave a TEDx presentation called Living an Extraordinary Life, documenting a 3-year experiment in living outside my bounds. Technical glitches made the video unusable, but I presented an expanded version of the same presentation with slides for the Harvard Business School Association webinar series a few months ago.

Living an Extraordinary Life

I’ve made the audio, the slides, and a synchronized version of the two available and want to offer it to my community. I’d love your thoughts and reactions.

Note that the MP3 file is tagged as an audiobook and can thus be listened to at 1.5x or 2x on an iPhone/iPod.

Do The Experiment With Me

I’ll be starting my Experiment again, and am offering it as a year-long coaching program to build a supportive community for others who want to join me. If you would like an invitation to the program, here’s how it works:

  1. Listen to the program and make sure it resonates with you.
  2. Contact me via the form on the web page to arrange a discussion.
  3. We’ll meet to explore your needs, what you have to offer, and find out whether you’re right for the program.
  4. If so, I’ll send along an invitation once the program and details have been finalized.

Enjoy!

Can you align business with ethics?

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Is business anti-ethical by nature? I’m reading an article today about how it’s in no one’s business interest to help protect consumers whose cell phones get stolen. Cell phone companies make more money when a customer’s phone is stolen, since the customer has to buy a new one. Furthermore, this logic applies to all cell phone companies, so even though it’s technically possible to permanently identify and deactivate a stolen cell phone, no player in the industry has the incentive to implement the technology.

Given that the technology certainly exists to disable a stolen phone, and customers spend hundreds of dollars on a phone, is it ethical for the cell phone providers not to help stop this, when (a) they could, and (b) they are the only people in the system who can?

This is a case where business interests and consumer interests clearly diverge. It’s a rather extreme version of Frito-Lay designing Doritos to give a rapidly-vanishing burst of flavor that psychologically hooks eaters into eating another chip. They know it’s unhealthy for people to stuff themselves on refined carbs, but they create a product designed to encourage exactly that. The cell phone companies, by not implementing theft protection, are encouraging cell phones to become the high-cost, high-tech equivalent of Doritos.

(How’s that for a tortured metaphor?)

I’m of mixed minds on this one. On one hand, I don’t know that it’s fair to force the phone companies to implement theft-protection on their phones, even thought it would stop an entire category of crime. But at the same time, no one else can do it, and I don’t know that I like the precedent of saying that business interests trump the societal interests of eliminating an entire category of theft and black market trading. (At the end of the day, I believe that we allow business to operate to benefit society, not the other way around.)

What do you think? Should phone companies add anti-theft technologies to their phones? Why? Is it morally/ethically appropriate on the part of the government/consumers to require companies to act? Is it morally/ethically appropriate on the part of the companies not to act?

Discuss.