Feb. 5, 2011

Vilfredo Pareto was an Italian engineer-turned-economist teaching in Switzerland at the turn of the 19th century. In 1896-97, he published a book on economics, Cours d'économie politique. It included a section on the distribution of wealth in Europe. He announced his famous finding: 20% of the population owned 80% of the wealth. He examined several Western European nations. The pattern held.

Ever since then, economists have studied wealth distribution in other nations. The law holds.

This is the single most important social law ever discovered. It is probably the most important economic law. No one has explained it. It defies reason. So, academic economists ignore it. Pareto's Cours has never been translated, despite being a universally acknowledged classic. It is arguably the most important still-untranslated book in the history of economic theory.

No one wants to deal with the 20-80 law in a scientific fashion. Pareto could not explain it. He devoted the last decade of his life to a study of society, trying to explain it. Nothing came of this. His explanation is hardly known. Yet this exercise moved him from an economist to a sociologist.

I list several academic discussions of the 20-80 law at the end of this article.

Pareto's law applies to society. It applies to biology. Pareto discovered that 20% of his garden's pea pods produced 80% of the peas. Here is a summary, found on a site selling a book on 20-80. These observations have been discovered over the years.

(a) 80 percent of the results are achieved by 20 percent of the group.
(b) 20 percent of your effort will generate 80 percent of your results.
(c) In any process, few elements (20 percent) are vital and many elements (80 percent) are trivial.
(d) If you have to do ten things, two of those are usually worth as much as the other eight put together.
(e) 20 percent of the tasks account for 80 percent of the value.

Pareto analysis can be effectively employed for separating the major causes (the "vital few") of a problem, from the minor ones (the "trivial many"). Such an analysis focuses your attention to tackling the major causes of the problem at hand rather than wasting time on the minor ones. The 80/20 rule has been tried and tested over the years but it has withstood the stringent scrutiny that it has been subjected to.

Application of the 80/20 rule in management

The Pareto Principle or the 80/20 rule proves its mettle in practically every area of management some of which are given below:

(a) 20 percent of the customers account for 80 percent of the sales.
(b) 20 percent of the products or services account for 80 percent of the profits.
(c) 20 percent of your stock takes up 80 percent of your warehouse space.
(d) 80 percent of your stock comes from 20 percent of your suppliers.
(e) 80 percent of your sales will come from 20 percent of your sales force.
(f) 20 percent of your staff will cause 80 percent of your problems.
(g) 20 percent of a company's staff will output 80 percent of its production.

It applies all the way up. If you add up the wealth of the ten richest men on earth, the top three -- Buffett, Gates, and Carlos Slim -- own 70%.

In other words, this is a true sociological law. If sociologists were really serious, their discipline would begin with this law, for it really is a law. There is only one law of sociology that is more universal: Some do. Some don't. Pareto's is more useful. But the sociologists can no more explain it than the economists can.

Sociologists are the most left-wing faculty members on any campus. This has been true for at least 50 years. So, their use of Pareto's law is highly limited. They use it to excoriate their own nation's wealth distribution. They produce detailed reports on this wealth distribution, but only for their nation, and only recently They never tell the reader that this distribution applies to every area of social organization. They do not tell the reader that it applies in ever nation ever studied. They do not tell the reader that, after a century of government attempts to bring economic equality, the 20-80 rule has not budged. Yes, some society may get 30-70. The United States today is 15-85. But this is variation around the mean: 20-80.

Why don't they discuss this. Simple. These fact prove that the sociologists' great unproved plans to bring equality will not accomplish this. But they want their reforms to work. It is a matter of religious conviction. So they use the Pareto distribution law to criticize capitalism, business, and Reagan (if they are Americans) or Thatcher (if they are British).

William G. Domhoff is the best example of this approach. He teaches sociology -- the most left-wing academic discipline -- at the University of California, Santa Cruz, which is arguably the most left-wing tax-funded university in the United States. For three decades he has asked this legitimate question: Who owns America. He revises his finding annually. He does the spade work in the economic statistics. I have no quarrel with his findings. I quarrel only wityh his refusal to discuss these findings as a tiny subset of a universal social law that no scholar has explained I criticize him for going on and on about how a truly just society would send men with badges and guns and steal back the wealth in the name of the people. Example (January 2011):

Figures on inheritance tell much the same story. According to a study published by the Federal Reserve Bank of Cleveland, only 1.6% of Americans receive $100,000 or more in inheritance. Another 1.1% receive $50,000 to $100,000. On the other hand, 91.9% receive nothing (Kotlikoff & Gokhale, 2000). Thus, the attempt by ultra-conservatives to eliminate inheritance taxes -- which they always call "death taxes" for P.R. reasons -- would take a huge bite out of government revenues (an estimated $1 trillion between 2012 and 2022) for the benefit of the heirs of the mere 0.6% of Americans whose death would lead to the payment of any estate taxes whatsoever (Citizens for Tax Justice, 2010b).

Notice the term "ultra-conservative." It balances "knee-jerk, envy-driven, bleeding-heart liberals."

Notice his use of the beloved decade-long statistic: 2012-2022. No one ever says "per year" when he is hyping his favorite tax reform panacea. That would not impress anyone. So, hypesters always choose a decade. This strategy is used by the Right and the Left. Whenever you see a decade figure, you know you're being manipulated.

I offer this response to Domhoff.

Billy, Billy, Billy: get real! The graduated income tax came in 1914. The brackets were hiked radically against the rich in World War I and have never come down to 1913. The super-rich use tax-exempt foundations to avoid paying the estate tax. That's why the foundations were invented by the lawyers who served the dynastic families your book shows rule America.

The original 1914 form for 1913 income is all over the Web. The Internal Revenue Service posts a photocopy of it on its site: http://www.irs.gov/pub/irs-utl/1913.pdf It was two pages long. Compare this with today's 1040 form.

Here were the brackets.

1 per cent on amount over $20,000 and not exceeding $50,000
2 per cent on amount over $50,000 and not exceeding $75,000
3 per cent on amount over $75,000 and not exceeding $100,000
4 per cent on amount over $100,000 and not exceeding $250,000
5 per cent on amount over $250,000 and not exceeding $500,000
6 per cent on amount over $500,000

There is a site that has a on-line calculator that lets us find out what our tax would be today, using the original form. Sadly, it fails to mention a crucial fact. The Federal Reserve System has debased the currency, beginning in 1914. According to the Bureau of Labor Statistics, goods and services in 2010 cost 22 times what they did it 1913. It has an inflation calculator that lets you see this. So, the income we receive today should be multiplied by 0.04 to see what it would have been in 1913. Most Americans today would pay no income tax. Of course, almost half of American taxpayers don't pay it today. You know the figures. You are an expert in the figures. You really ought to tell your readers the whole truth.

http://www.ntu.org/tax-basics/who-pays-income-taxes.html

You also know that Progressive Republican leaders got Congress to promote the Sixteenth Amendment.

After almost a century of the New Freedom, the New Deal, the Square Deal, I Like Ike, the New Frontier, the Great Society, the New Malaise, Morning in America, a Thousand Points of Light, the Abolition of Welfare as We Have Known It, the Ownership Society, and Change We Can Believe In, we still have a more unequal wealth distribution system than we had in 1913. Right?

The voters refuse to change the tax burden. The Federal government extracts pretty much the same percentage, 15% to 20%, year after year.

http://en.wikipedia.org/wiki/Taxation_in_the_United_States

Your figures show that the distribution is beyond Pareto: more like 15-85. OK, it's bad, as in "more unequal." But it's bad by five percentage points. No society gets below 20-80. Let your readers know that "bad" is measured against 20-80, not 50-50. There is no 50-50, ever.

Lest I be thought of as a mean guy who beats up only on left-wing hypesters, I want to state the case against right-wing hypesters.

Guys, it's time to stop spreading the party line about the free market as an engine of wealth equalization. It isn't. It's time to fess up: trickle-down economics is what the free market produces. So does socialism, which you do mention, and the Left doesn't, but wealth does trickle down. Pareto's law applies everywhere.

You need to come to grips with Domhoff's tables and charts. It is not fair to keep pretending he doesn't have the facts just because he is a Leftie who wants to send out guys with badges and guns to soak the rich. Here is reality.

http://sociology.ucsc.edu/whorulesamerica/power/wealth.html

You should stop ignoring Domhoff and stop ignoring Pareto, too. Reagan lowered income tax rates in 1981, with the Democrats mostly going along, following Kennedy's tradition of lowering rates, but he signed the TEFRA tax hike in 1982, and he raised Social Security rates in 1983, which Carter had promised six years earlier would not be necessary until 2000. Social Security is becoming the killer, and it's now running a deficit. Look at where the money comes from.

http://en.wikipedia.org/wiki/United_States_federal_budget

It is time to stop pretending that the inequality of wealth distribution can be cured by a flat tax or a VAT tax or any other kind of tax. The free market will not produce a society in which the top half of the citizens will pull in only half of the income and own half of the capital. The low-tax reforms will not work, any more than the Left's "I like Ike" 91% top income tax bracket worked.

For confirming evidence in the form of a slide presentation, click here.

Under the free market, the rich get richer, and so do the poor. The rich get far, far richer.

Under Communism, the rich get a little richer, and the poor get a lot poorer, but the rich in a Communist society are poorer than the middle class in a free market society, and will be poorer than the bottom 20% after a few more decades. The top Communists figured this out in China in 1978 and in the Soviet Union in 1991. They have yet to figure it out in North Korea and Cuba.

Conclusion: Until there is a cogent explanation for the existence of Pareto's law, there can be no government policy that will overcome it. The explanation will probably be that nothing can change it. Get used to it.

On the background of Pareto's 20-80 law, begin here.

http://en.wikipedia.org/wiki/Pareto_principle
http://en.wikipedia.org/wiki/Pareto_index

The best introductory book on this is Richard Koch's The 80-20 Principle: The Secret to Achieving More with Less. A good summary is here: http://personalmba.com/8020-principle.