Saturday, April 17, 2010

The Accidental Egalitarian: Technology and the Distribution of Income

This represents my personal opinion, not the views of the SEC or its staff.
This month’s Institutional Investor AR magazine came out with its list of the highest compensated hedge fund managers. I already have expressed my doubts about the accuracy of their approach, though you can adjust the numbers by an order of magnitude and it is still off the charts. But for all that is being written about hedge fund managers and their poorer cousins, the banking elite, about the expanding income gap, and about the new frugality and the changing American dream, the differences between the very rich and the rest of us are shrinking.

Up until the last part of the 1900’s, F. Scott Fitzgerald’s observation that “the very rich are different from you and me” certainly was true. And it wasn’t only, as Hemmingway later quipped, that they had more money. It was how that money transformed their lives and how it variegated society. But no longer.

This might sound like a preposterous statement. But when we use the dollar differences in income to measure the gap, we are measuring it the wrong way. What matters is the practical impact, how the differences in income carry through to make a difference in how we live day by day, even hour by hour. A head to head income comparison does not measure that; it misses the effect of work habits and lifestyle, and, most critically, the effect of technological progress on filling in the income gap. Don’t stop with dollars earned. Ask how people earning those dollars spend their time.

There is one thing everyone has in common, no matter what their income: They have twenty-four hours in a day. So differences in income can only be expressed by what they do in those twenty-four hours, and how they do it. Let’s observe snippets of a typical day in the life of Billionaire Malcolm III and compare it to high-earning Professional Bob and think about how much the thousand-fold income differential between the two leads to differences in what they are doing and how they do it; how many minutes of the day their activities differ.

A starting assumption is that both Bob and Malcolm III work hard. You probably do, too. You wouldn’t run off to spend the rest of your life on a beach in the south of France, really, even if you could. If the lifestyle in the get-rich-quick infomercials of sitting with unbounded leisure time is your end game, then you are on a different fork of the road than where this discussion is heading.

Now let’s look at the time that Malcolm III and Bob spend on their workday activities and see what that extra billion does:

Sleep Time. Seven to eight hours of the day, they are both asleep. They have beds, black-out shades and a sound machine. So right off the bat around a third of the day is the same.

In the morning. They shower, shave and get dressed. We are past the age of butlers drawing baths and helping lay out clothes, so there is no differences in this realm. And it’s dress-down day at work, so they both have on jeans and a polo shirt. They grab a coffee and bagel for breakfast. For Malcolm III it is ready and waiting in the kitchen thanks to his housekeeper. Bob stops for his on the way to work – his live-in girlfriend has already left and forgot to turn on the coffee machine. Still no difference worth thinking about.

To the office. Malcolm III has a driver to take him to the office, Bob takes a taxi. Or drives himself. Bob’s car is an Acura TL Type S. Malcolm has, among other cars, a Porche 911 Turbo. On the open road, it can leave Bob’s Acura in the dust. Too bad they live in New York and not Frankfurt.

At work. They both are at their desks dealing with e-mails and then plan to spend some time polishing a presentation. Malcolm III has a team of administrative assistants outside his office to take care of his mundane tasks like travel and insurance. Bob has one secretary, and she does the same for him. Malcolm’s office is spacious with an antechamber, a sitting area and a lot of doo-dads and pictures with celebrities on his bookshelves. But look at what Malcolm and Bob are actually doing. They are engaged in the same sort of work with the same sort of equipment, and for all practical purposes they are occupying a forty square-foot world. For lunch they both eat a sandwich at their desk.

In terms of their workday,
I am ignoring some characteristics that we associate with the Malcolm’s of the world, things that really don’t have to do with Malcolm’s wealth per se. For example, he oversees many people and he can order those people around autocratically. His underlings have to listen to his philosophical views about building an open work culture, which make their way into company-wide e-mails and a spiral bound volume that he hands out around bonus time. These are coincident to being a billionaire, but being a billionaire is not required to have these trappings. There are generals, CEOs and government bureau chiefs in the same situation. And army lieutenants and factory floor supervisors.

Evening Activities. Unwinding after work, they both happen to end up at The Modern, next to the MOMA, to meet business associates. Then off they go, home to have dinner, spend some time on the web, and then watch a movie. Malcolm III is doing this in a house that is five times the size of Bob's. Malcolm III’s house is a sprawling estate with a living room, dining room, library, sitting room, billiard room, sunroom, solarium, four fireplaces, a guest cottage and a pool. It has a large entry with a spiral staircase, marble floor, and mahogany woodwork. And so on.

But it doesn’t matter – he is in a 200 square foot room to the side of the kitchen sitting on his couch twelve feet from his big-screen surround sound set, beer in hand, just like Bob is.

Of course, there are some big differences, differences that will be manifest maybe twenty or thirty hours of any given month. Bob takes commercial flights, upgraded to business class, while Malcolm flies in his private jet. Malcolm shells out to be on various charity boards and spends time at gala events. In terms of pastimes, if Bob’s passion is breeding racehorses, the America’s Cup or collecting big name contemporary art, too bad.


Depending on their personalities and philosophical bent, even these differences might not matter all that much. For example, if Malcolm III is environmentally conscious, he doesn’t take a private jet. He drives a Prius rather than a Porche, and even takes the subway to work. If he is introverted or nerdish, then rather than hobnobbing at the black-tie events, his idea of a good social gathering is a small dinner with his friend who writes for Wired and the one who is researching nano biotechnology. And he will not care much about items of conspicuous consumption, because he doesn’t care about being conspicuous.
Many in the technology sector have promulgated this ethos; it is an egalitarian side effect of the boom in technology.

The point of this is to illustrate that the day-to-day impact of wealth is lower today. A century or so ago, in F. Scott Fitzgerald’s era, there was little time during the waking hours when the activities of the very rich did not differ from those a rung or two down. Even if we look back a few decades we see that gaps have disappeared. Back then, only the wealthy could have a screening room in their home; drivers would stick fake antennas on their cars to impress passersby. Now Joe and Malcolm have the same computers, high-definition TVs, Blackberries and i-Phones, game systems, Kindles, cameras – and these are the things that occupy most of their non-sleeping, non-showering lives. In fact, in terms of hour-by-hour activities, my kids are more Malcolm-like in many respects than I am. They have iPhones, Tivos, large screen monitors, Playstation 3 game systems, and subscriptions to netFliks. I don’t.

This analysis is interesting as far as it goes. Indeed, that it only goes so far is what makes it interesting. What I did for Malcolm III and Bob could also be done for the professional versus the skilled salaried worker, the skilled salaried worker versus the unskilled hourly worker, and so on down to those in extreme poverty working for a dollar a day. But as you continue down the income ladder from the Professional Bobs of the world, another dimension beyond how people are spending their hours becomes of increasing importance.

Drop one more order of magnitude in income and compare Journalist Jamie to Malcolm III and Bob. The hour-by-hour comparisons will still work; Jamie will not differ that much from Bob in what he is doing with his time; certainly the differences will be far lower now than they would have been even a few decades ago. Even though Jamie does not have a secretary to help with his daily tasks, he can quickly dispatch most everything on line – except for the crazy time spent on hold with insurance and the cable company.

But Jamie has a lot to worry about that Malcolm and Bob do not. Malcolm will never have to worry about money, Bob has a large nest egg to protect him against a downturn in his work, but for Jamie, one false step, and he has no way to pay for his house, no health insurance, uncertain prospects that extend out to the future opportunities for his children.

The reduction in the practical implications of income differences at the higher end of the income scale has created a plateau where there used to be a hill. But that plateau has a stark cliff at the edge. Jamie might be on the plateau shared by Malcolm and Bob, doing much the same with his time as they are, but he is closer to that cliff. If Jamie loses his job he is no longer looking down at the abyss, he is over the edge.

The flatter the plateau and the more sudden and deep the abyss, the stronger the argument for social programs, because the costs of redistribution for those on the plateau are lower in practical terms, and the fall from the plateau is more crushing. In the limit, if the plateau is completely flat, so that there is no practical difference in income within the upper range, people should be indifferent about moving along that plateau toward the cliff if at the same time the cliff can be securely fenced off.

Put in other terms, more akin to the way we think about financial trade-offs, there is both the expected value of one’s income (measured by what it does for you in practical terms) and the uncertainty surrounding it. As the means from one person to the next converge, the uncertainty takes on increasing significance. As the “how you spend your time” differential shrinks, a reduction in uncertainty through an improvement in the safety net becomes of increasing importance. Indeed, in the limit, if everyone is typically spending their time doing the same things, reducing this uncertainty is all that matters.

12 comments:

  1. Well, Rick, you almost had me there.

    You talk like there lies a pit of fire or sharp spikes if someone loses their job. You talk like someone falls off the edge never to be heard from again. Yes, there is suffering, people generally don't go hungry, and they adjust.

    If a person's lifestyle is guaranteed, what motivation is there to work? There are already safety nets in terms of food and shelter in every city in America.

    Socialism not only has a broken moral foundation for taken from one group people by force to give to another group of people, it has been a profound failure in world history everywhere it has been tried.

    There is a homeless man in my town who gets his food and shelter for free and spends his days surfing the web in the public library. Your point is an excellent one. This man is already living the life of a leisured aristocrat as it is.

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  2. Hmmm... Did Dan just call you a Socialist? Ahhh... America! Gotta love you guys!

    Uncertainty is a fairly abstract concept. It brings stress to mind, and perhaps health related consequences.

    Would you ever catch Malcolm or Bob eating McDonald's every day?

    I'd love to see what you would come up with if you turned your attention toward the food business. Starting from corn and soy, and up the chain.

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  3. An accurate update of the convergence of lifestyles in Western countries since the industrial revolution, but you're ignoring the usual motivation for wealth. It's not how much you have, it's whether you have more than your neighbours or golf buddies or other peer groups.

    The "accidental millionaires" of Silicon Valley lack this motivation, so their wealth gets nibbled away by bad investments, bad advice, expensive toys, expensive spouses, etc.

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  4. Bookstaber wrote: "people should be indifferent about moving along that plateau toward the cliff..."

    Isn't this a metaphor for the new tax and spend ideology? Everyone should be forced to stand at the edge of a cliff building fences and hoisting the less fortunate up the side. Society will be better off until a rainy day arrives and the cliff turns into a fiscal landslide. Since we will all be standing at the edge, we as a society will collectively go tumbling over the edge at once.

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  5. Rick,

    I enjoyed the first 80% of your article. I think a stronger argument can be made that as wealth increases, impact on lifestyle decreases; very similar to a utility curve.

    You lost me on your social safety net logical leap. You, as well as anyone, should know that if you hedge out all risk, the best return your can expect is the risk free rate (and it’s pretty easy to do worse). Have you considered the idea that the reason lifestyles are converging is that we live in a society where we are encouraged to take on risk.

    Finally, we should also consider what lifestyles are converging towards. Convergence is not an end in itself. We could converge towards an increasingly technologically luxurious existence, or towards miserable subsistence existence. It’s certainly possible that as social safety net increases, average lifestyle decreases (or doesn’t increase as fast).

    -DB

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  6. Being born and raised in the USSR (it became "former" after I left), I have to agree with the first commenter Dan that the "plateau with a fence" world sounds pretty socialist (or communist). And as Anonymous said, that simply will cause people to sit "on the fence," so to say. And people are VERY inventive--they won't work hard and productively to get to the fence, and then relax. They will cheat and bribe and steal to get themselves to the fence and stay there.

    I like the following quote from John Stuart Mill in The Principles of Political Economy: "It is the common error of Socialists to overlook the natural indolence of mankind; their tendency to be passive, to be the slaves of habit, to persist indefinitely in a course once chosen. Let them once attain any state of existence which they consider tolerable, and the danger to be apprehended is that they will thenceforth stagnate; will not exert themselves to improve, and by letting their faculties rust, will lose even the energy required to preserve them from deterioration. Competition may not be the best conceivable stimulus, but it is at present a necessary one, and no one can foresee the time when it will not be indispensable to progress."

    We haven't figured out the next societal structure quite yet (I'll let you know if I do). But, until either such structure is found, or humans somehow evolve (which I don't think is possible--c.f., homo sovieticus), we can't be having any "fences" that are too safe (yes, minimal food, shelter and perhaps some emergency health care--but not more).

    Also, while I agree that hour by hour differences have decreased somewhat, the discussion ignores (a) the "keeping up with the Joneses" (which is much more powerful now when EVERYONE can see on TV how and where the super-rich play) and (b) that it's not the hour by hour differences that matter.

    The fact that Malcolm and Bob both sleep and shower is about as relevant as the fact that both my dog and I both sleep and eat. Although, Malcolm and Bob may both spend some hours in the office doing similar activities, again, it's like comparing a writer composing a masterpiece to a CPA entering numbers into his tax program near April 15th. They both use a laptop, but their activities are qualitatively not even on the same planet! Now, Malcolm probably spends 3 or 4 days in the office, and then he can do whatever he pleases--literally (fill in the blanks here with gusto, please). Even if Malcolm is still working extra hard, his work is going to take him out of the office much more than Bob's. Bob works at least 5 days a week, and likely 7. When he is not there, he probably enjoys himself, but in a way that would seem as limited to Malcolm as my dog's day seems to me.

    My point here is that differences in physical activity per unit of time averaged over 24 hours during person's middle working age is a poor measure of equality. Freedom to act, peace of mind, leisure activities, retirement age--these things matter more. If these are too "subjective", then we can turn to the only "objective" measure we have--amount of money. And here, as we know, Malcolm is about 1000 times better off than Bob. :)

    On a side note: why is Malcolm III in business, and not, say, sports or entertainment (granted, he/she is unlikely to be a billionaire then, but can easily be a multi-millionaire)? In that case, even the measure used in the article may show large differences.

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  7. Interesting thought experiment.

    One might conclude that it would be great if you could buy "lifestyle insurance." After all, as you conclude, the dominating difference as you go down the income ladder is not the day-to-day recreation and quality of life, but rather the increasing risk that you will have to sacrifice some quality of life.

    There already is some "lifestyle insurance" of various sorts: Privately you can buy insurance against disabilities and accidents that would otherwise "send you over the cliff." The government also provides an array of "lifestyle insurance" entitlements, from unemployment to disability insurance. But note that these are notoriously rife with corruption.

    It seems that you cross the line to "socialism," with all its perils, when you try to come up with either (1) a blanket lifestyle insurance program or (2) lifestyle "assurance" that guarantees people a quality of life regardless of whether they have earned up to it.

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  8. The contrary aspects of money are useful to address. I call it God's Joke - you get a whole lot of money and then what can you do with it!?

    However, if we look at money as proxy for social power we are into evolutionary/selective reproductive advantages articulated here from recent research:

    “Power = increased rewards,freedom and approach-related tendencies. Reduced power = increased threat, punishment, and social constraints and thereby activates inhibition-related tendencies.
    Power is associated with
    (a) positive feelings/mood
    (b) attention to rewards
    (c) automatic information processing
    (d) disinhibited behavior
    In contrast, reduced power is associated with
    (a) negative feelings/moods
    (b) attention to threat, punishment, others’ interests, and those features of the self that are relevant to other’s goals
    (c) controlled information processing
    (d) inhibited social behavior

    There are physiological and brain correlates of this as well.

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  9. Disparities of wealth need not be justified by their effects on lifestyle or life satisfaction. Wealth is power, and capitalism puts wealth into the hands of those who will make the best use of it. Societies that undermine this will turn dismal and wither.

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  10. Absolutely.
    And this is why I think in this deep crisis millionaires should donate a lot of their wealth and engage in massive philanthropy to alleviate the burden that our system has put on taxpayers, retirees, unemployed and dependants.
    Either this world becomes fairer or communism will be back to spoil the party for all.

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  11. Rick,

    While I agree with your conclusion that reducing the uncertainty surrounding one's income is all that matters in an individual's day-to-day life, the evidence you use to build your case seems largely detached from reality as I know it. Your assessment seems to be drawn from an altitude of about 30,000 feet. Having spent much of my life living and working at the level of mycorrhizal fungi in our social order, I have a much different perspective.

    My immediate gut response is akin to that of SleepRunning, who speaks to the relationship between money and social power. I've spent much of my life witnessing the "disinhibited behavior" of those with money. Living in Las Vegas, one tends to see the worst of human disinhibitions. Having worked as a social worker in this community, I have witnessed and felt the "attention to threat, punishment, others' interests, and those features of the self that are relevant to other's goals." The latter is just a sophisticated way of saying, "living in fear of becoming a predator's meal."

    For me, your analysis loses credibility because it fails to take into account the predatory nature of our economic system. A more useful and realistic analysis might look at how Malcolm preys upon Bob and how Bob preys upon Jamie. And also, how, if Jamie slips over the edge of the abyss to be caught by a social safety net, Malcolm and Bob feel preyed upon by Jamie.

    What we are lacking here is a means of measuring the relative weight of predation on each of the players in our thought experiment and how money tends not only to insulate one from the talons and fangs of predation, but also to attach talons and fangs to the most innocuous actions of those living on the high plateau of wealth. We also lack a means of measuring the force and design with which economic predators drive the naive, ignorant, and overconfident members of our fold to the abyss.

    A more useful analysis might look more deeply at the day-to-day behavior that each of our players by examining the choices that each player makes and how those choices consequate across the globe. For example, how did Malcolm make his billions? Trading commodities like oil? Is he a major stockholder in BP? Is he on the executive board of BP? Has he been putting pressure on BP managers to show better quarterly results at the expense of safety?

    Or in the case of Bob, has Bob been working at the SEC for the last twenty years doing his level best to protect consumers from predatory investment banks? Has Bob learned that the SEC marches to the drumbeat of the Wall Street giants and that diligent moral behavior is more likely to suffer punishing rejection instead of hearty approval and support?

    And so on . . . .

    Ultimately, I think we need to keep the edge on the abyss but soften the slope and add some handholds and footholds to allow for self-recovery. We also need to put a leash on the predators who engorge themselves on those weak, unwitting, or ill-fated souls who stumble haplessly or not so haplessly into their killing zone along the edge of the abyss. I also believe we need to reinstate the "Death Tax" with a vengeance on those individuals and families whose most challenging choice in life has more to do with personal fashion than survival of the species or planet.

    I believe everyone should have the opportunity to get acquainted with the world of mycorrhizal fungi. It's really a beautiful place, as long as you are open-minded about how your neighbors look and behave.

    Keep up the good work. You're on a great mission.

    Cheers,
    Garth

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  12. At the top of the world, you have Bill Gates, Vinod Khosla, guys that can steer billions by whim of their opinions. Then you have your politicians and congresspeople, that can do the same, way way of legislation. After office, they exist on the network of dole. Then you have your millionaires like Michael Jordan that can almost do whatever they want, buy whatever they want, and never work a day in their life.

    Below that are the working people. Just an ounce of bad luck, and all their life savings poured into their mortgage, gone from foreclosure. Or a bad hospital bill, etc.

    And you have people that don't even have the chance to get foreclosed on, those without air conditioning, homeless.

    Yes, money doesn't matter "much" for the upper income brackets, but it still certainly affects a lot of us, and it won't change for decades.

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