Lies and Statistics

Author: Greg Price
Date: 1 March 2003
Words: 556
Publication: The Australian Financial Review
Section: Comment and Opinion
Page: 51
Source: AFR

Earlier this year, Labor's Wayne Swan expressed concern that the income of the top 5 per cent of Australians was increasing at a disproportionately high rate. That's not surprising, according to Israeli economist Moshe Levy.

The rich increase their wealth through capital investment, Levy suggests. Their wealth distribution falls on a Pareto curve - the same curve that describes the distribution of stockmarket returns. The curve is an expression of the repeated multiplication of stock returns, as gains are reinvested and winners quickly outstrip losers.

Wealth inequality is particularly high among the rich; in a Pareto distribution, 20 per cent of people have 80 per cent of the money. However, wealth inequality is also high for the poorer 95 per cent.

US academic Victor Yakovenko has analysed the distribution of money in the US and the UK. He finds that it falls on an exponential curve, known as the Boltzmann-Gibbs distribution. This is startling, because the Boltzmann-Gibbs law is meant to describe the distribution of energy among gas molecules.

In a closed system, gas molecules collide with each other and exchange energy in a random fashion, tending towards an equilibrium distribution of energies that traces a highly unequal exponential curve. Most of the atoms are clustered at the lower energy range, with a small number in the high range.

For some reason, there appears to be a deep statistical similarity between the way gas molecules randomly exchange energy and the way money flows between individuals in a market economy.

Roughly translating Yakovenko's graphed US findings, you find that the top 10 per cent of families get about 25 per cent of the total income, the top 20 per cent get about 40 per cent of income and the top 50 per cent get about 75 per cent of income. Meanwhile the lowest 20 per cent get only about 5 per cent of total income.

This highly unequal distribution can be characterised by a measure of inequality called the Gini coefficient. The Gini rises from zero to one as inequality increases. The Gini coefficient for the US distribution is 0.5 for individuals and 0.375 for households with two or more incomes. The US has hovered close to these numbers for 50 years.

The European and North American economies also have Ginis of about 0.5 and 0.375, Yakovenko finds. He suggests these numbers describe the income distribution of a mature market economy.

Australia seems to fit the US and European pattern. ABS income data collapses single and multi-income households into one unit and gives a Gini of 0.45. This puts Australia on the same curve as the US and UK, Yakavenko found after some rough calculations this week.

It seems that a high level of income inequality is a fundamental characteristic of a market economy.

Greg Price writes business advice for a US accountancy network.