Guest Post: The Pareto Economy

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

The Pareto Economy

The Pareto distribution suggests that costs could be cut by 80% across the entire economy.

Economist Vilfredo Pareto's (1848 - 1923) data-driven discovery that 80% of the land in Italy was owned by 20% of the population led to the Pareto principle, known as the 80/20 rule. Research has turned up an astonishing range of natural and social examples of the 80/20 rule: fixing 20% of software bugs eliminates 80% of the tech support calls, 20% of the customers are responsible for 80% of the complaints, and so on.

The Pareto distribution is not a Newtonian law of precise prediction, it is a power law probability distribution: it projects probabilities and ranges, not exact numbers. For example, the top 25% of U.S. wage earners pay 87% of the Federal income taxes. The point is not precision but the basic distribution.

The 80/20 rule can be further reduced (80% of 80 is 64 and 20% of 20 is 4) to a 64/4 rule: the 4% "vital few" have outsized influence on the "trivial many" 64%. We can see the rough outlines of this distribution in income and taxes: The top 1% of taxpayers reported almost 17% of all taxable income and paid 37% of all income taxes; the top 5% reported 32% of all income and paid 59% of the taxes, and the top 10% earned 43% of the income and paid 70% of the taxes.

As I have often noted, most recently in The Fiscal Cliff's Structural Endgame (December 28, 2012), and Why the Middle Class Is Doomed (April 17, 2012), roughly 70% of all financial wealth is held by the top 5%. That is remarkably close to the 4%/64% distribution we would expect.

Can 4% of Homeowners Sink the Entire Market? (February 21, 2007) Answer: yes, 4% of mortgages defaulting collapsed the global housing bubble.

The Pareto distribution has another application: cost-benefit analyses. Though it is more difficult to substantiate than ownership of assets or taxation, we can estimate that accomplishing 20% of the standard diet/fitness recommendations yields 80% of the health benefits.

A small, simple house that costs 20% of the average U.S. new home reaps 80% of the benefits: privacy, ownership, a warm place to sleep, etc. (Having built a plywood cabin by hand in 1978 that is still doing duty, I would go further and say a dwelling that cost 4% of the average home construction cost provides 64% of the benefits, as long as minimal electricity and indoor plumbing are included.)

This distribution of costs and benefits has profound macro-economic consequences. The U.S. "healthcare" i.e. sickcare system costs twice as much per person as competing nations' healthcare and still leaves tens of millions of people uninsured or underinsured. Though those profiting from sickcare will of course deny it, we can project that spending 20% of the current wasteful cartel/crony-capitalist system's budget would accrue 80% of the beneficial healthcare.

We can go on to project that 20% of the defense budget accrues 80% of the actual national defense provided by the U.S. military (as opposed to cartel/crony-capitalist weapons procurement and Imperial over-reach).

The applications of the Pareto distribution are endless and extremely thought-provoking. 80% of the potholes could be filled with 20% of the city street-repair budget. 20% of the food harvested could provide a nutritionally adequate diet for 80% of the people. (if you doubt this, recall that we waste an estimated 40% of our food and food products output, and it takes 3 to 15 pounds of harvested fish to grow one pound of farmed fish.)

What if 20% of the time spent in meetings produce 80% of the work/decisions?

Does anyone seriously doubt that spending 20% of the conventional cost ($120,000) for a four-year college degree would yield 80% of the quantifiable education gained?

If one car is shared by five people, 20% of the cost of vehicle ownership yields 80% of the benefits of ownership.

You see the point: roughly 80% of the U.S. economy is waste, friction, skim, fraud, profiteering and diminishing-returns inefficiency. Any system that spends 80% of its surplus on diminishing returns is doomed to insolvency.

This terrifies the conventional economics cargo cult because it suggests the market/state cannot provide jobs to 95% of the working-age populace.

Within the high cost-basis Status Quo, this is true. Few can afford to hire workers to perform marginal-return work, and few people can afford the absurd costs of education, healthcare and housing.

The solution is to radically lower the cost of living (education, healthcare, housing, governance/government) and reinvigorate the forgotten foundation of human life, the community. I discuss this further in my most recent book, Why Things Are Falling Apart and What We Can Do About It.

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bank guy in Brussels's picture

OT

Parties on resisting the EU and bailout dictation, including Communists, have deprived the leading candidate of victory in the Cyprus presidential election today ... now there will be a run-off Feb 24

http://www.aljazeera.com/news/europe/2013/02/2013217154818925245.html

Kitler's picture

80% of Americans utilize 20% of the nations total brainpower.

(It may actually be safer for us all that they don't attempt to think...)

CH1's picture

I disagree with this: The solution is to radically lower the cost of living.....

The solution is to stop obeying liars and thieves.

MrX's picture

80% of the weed is consumed by me.

don't miss this one: http://vimeo.com/43832369

Manthong's picture

I was going to say that maybe if we string up about 5% of the bankers and politicians we could fix 95% of our current problems, but then it seems, on an exponential curve, to follow that if we string up 95% of them we could solve fine nines (.99999) of our problems.

goldfish1's picture

If four cures sixty four...four's a good number to start.

macholatte's picture

 

let's see.....

there was a 4% chance a half breed communist muslim would be elected president but an 80% chance the elections could be rigged with 20% dead people voting and 64% not voting at all.

 

It is enough that the people know there was an election. The people who cast the votes decide nothing. The people who count the votes decide everything.
Joseph Stalin

qqqqtrader's picture

80% of the talking heads on CNBsC have an IQ of 20,

and the other 20% have an IQ of 80

johnQpublic's picture

if they go after 20% of the guns, someone will eventually figure out how to take down 4% of the grid

 

and i am 100% sure of that

Frankie Carbone's picture

I'm a 6-sigma guy myself. So that means shoot 99% of them and auction the remaining 1% off as trophies to the highest bidder.

Anusocracy's picture

20% of 20% of 20% drive progress and civilization.

20% of 20% of 20% undermine progress and civilization.

How the remaining side with those two groups decides the fate of a society.

 

Motorhead's picture

It used to be the "ten percent".  Blame it on inflation, I guess.

Raymond K Hessel's picture

It was never 10 percent.  WTF are you talking about?

Motorhead's picture

You never heard the old saying about the 10 percent?  Get a grip, chump (or put the bottle away).

matrix2012's picture

e.g. Imelda Marcos once was well-known as Mrs. 10 percent in Philippines. Honestly I ain't sure if such 10 percent has been inflated to 20% nowadays.

Taint Boil's picture

 

 

Always good stuff from Of Two Minds! .... well, 80% of the time

dick cheneys ghost's picture

The 1% can kiss 80% of my ass..............

Yen Cross's picture

 I just want to take time to welcome Z/H contributors, < back into the envelope<

DoChenRollingBearing's picture

There are many distributions that are far more skewed than 80/20, even in sales of a company's products.  Our bearing sales in Peru, for example, are about 90/10.

Further research into distributions of this kind are fairly urgently needed, IMO.

Matt's picture

There is a way of taking into account deviation from the 20/80 ratio; for example, if fewer than 20 percent of the people have more than 80 percent of the wealth, the country has less equality.

The principle is not just about property owners and income tax; the same mathematician discovered that approximately 20 percent of the pea pods in his garden produced about 80 percent of the peas, for example.

trillion_dollar_deficit's picture

Similarly, I use this all the time in healthcare analytics. The general rule is that the top 20 procedures in lab/rad/surg/drg/cpt/etc. yield 80% of the total volume. 

DoChenRollingBearing's picture

Yes, Matt and trillion_, + 1

The 80/20 Rule pops up up everywhere!

I was referring to the fact that there are MANY cases of more skewed distributions than Pareto's 80/20.  Here's an interesting book that I read about 80/20:

Koch, Richard  The 80/20 Principle  Doubleday, 1998

Anusocracy's picture

Perhaps the 80/20 rule has its basis in bell curve distributions.

trendybull459's picture

The author is wrong on apply the Law of the PAretto twice,this rule shows real Elite % toward % of population they are try to control and this is 80% rule to the 20% from 80/20,because bewtween Elite also going the War,like right now between politicians and elities and the Banking industry which suppose to be the Scape Goat,because they created overburden ballanse which bended to Elite the hands,so,real rule is 96/4(80% from 20% is 16 from 20,so we plus those Elities who went victims of the system into middle and lower classes to the 80% of the slavory population),as soon as Paretto Law makes proportion becoming into over 96% -critical point,ballance which should not be overcomed by high number,as the Revolutions following,usually because Elities forgot to keep healthy proportion and became hunger too much,the proportion of the PAretto actually applies to the Stock Markets where he was specialist,his brilliant work was based on much earlier psyhological research which later Ung and Freud use in their works,forexample Foretter found that in family where was alchogolic during 6generation should be born alcocholic and if in family was killer,then due 6generation Must born killer,but if not-it will not happend next generations,thats why our parents was following the families trees,because this was helping to manage healthy outcome and unhealthy outcome for the family,which of the habits could appear and which gone in next generations

we got new Forum in russia and in russian,but you can talk english(as most russians speaking it),to leave comments in translite or russian,what is good is that Russia absolutly free country if it apply to critics of their enemies,it takes some few minutes to be free from Big Brother watching being registred in Mail.ru

http://trendybull777.blog.com/

Yen Cross's picture

  Paragraphs help?  A person with your wisdom/calibre, kNOWS how to >indent?

Monedas's picture

Trendy mispells 20% of his words .... the other 80% of his errors are diction and punctuation and typos !

Taint Boil's picture

 

 

I prefer all caps and in bold - easier to read

Frankie Carbone's picture

And sentences less than 500 words always helps too!

Peter Pan's picture

I think that the 80/20 rule is about right when describing what the governments rips out of the economy as opposed to what you get to keep.

McMolotov's picture

Sixty percent of the time, the 80/20 Rule works every time.

disabledvet's picture

"90% of this game is half mental." Yogi Berra. that would be 9 time World Series Champion...Yogi Berra.

Shell Game's picture

I recall a lone voice in the wilderness proposing to cut $1 Trillion from the federal budget - not 10 years from now - but this year.

Imagine the pleasure of saying 'What TSA? What Dept. of Interior & Education? What Depts of Energy, Housing and Urban Development and Commerce? They don't exist!

 

Fucking Statist establishment...

 

Welfare and Warfare Nation 4Eva!

Panafrican Funktron Robot's picture

The Wall St. Journal came out with a budget tool a while back (can't find it now) during the last budget battle back in December, I took it out for a spin and noted that if you just take out some tax breaks and add in a bunch of common sense cuts, you end up with about $850 billion in the black, this year.  So, the question really shouldn't ever be "can they technically do it", because it's very, very obvious that it can be done.  It just won't be done.    

orangegeek's picture

80% of unionized workers do 20% of the work they are supposed to do.

 

Hey!  This really works!

 

80% of government provides 20% of the value that they are supposed to provide.

 

Wow!  Another one!  Holy shit!!!

Rustysilver's picture

20% of the products bring in 80% of the profits.  My memory of Pareto.

Yen Cross's picture

 I've been up too long. Red arrows are great (inference). Be well Bitchez.

sunnyside's picture

As the hyperventilation about sequestration increases, I'm struggling with some of the details.  As I understand it, sequestration would cut 85 billion per year.  We are running 1 trillion deficit per year.  They are screaming over less than 10% of a fix?????  If this is a problem, then it is obvious there is no way this gov't has any will to fix it.  Why give a fuck anymore and even make a pretense to participate in this charade?

NoDebt's picture

Exactly.  Find a good seat and strap in. 

Not to pick nits, but it's $1.2T a year.  But what's another $200B a year between friends, right?  We can find that wadded up in the back of our sock drawers (though, apparently sequestration can't get us that much).  Oh, well.  Not to worry.  It'll all work itself out fine in the end, I'm sure.

Welcome to ZH.

itstippy's picture

"As I understand it, sequestration would cut 85 billion per year."

The Fed is printing $85B per month.   What would happen to the economy if Bernanke really did reverse course and began selling Treasuries & MBS instead of buying, as he insists he will eventually when the economy "gets on better footing"?

"Why give a fuck anymore and even make a pretense to participate in this charade?"  That's the $85B question. 

There's a bad moon on the rise.

McMolotov's picture

"They are screaming over less than 10% of a fix?????"

More to the point, these are people who seem to believe they're "cutting spending" when they propose a slightly-smaller-than-wished-for increase in spending. It's best not to think too deeply on what motivates such imbeciles, lest you invite insanity.

Monedas's picture

"20% of the population is responsible for 80% of social service spending !" .... NAACP

Monedas's picture

"Is that a sardine in your knickers .... or are you just venting pheromones .... because you want me to fuck you ?" .... Pick up line in southern Italy

Smegley Wanxalot's picture

80% of inflation results from 20% annual increases in the printed money supply.

Stuck on Zero's picture

The pareto distribution carries over into the relative sizes of animals and of corporate dominance in markets. 

 

Super Broccoli's picture

here is another rule / paradox : 99% of the people don't understand a fuck about what's happening right now while they're responsible for this mess !

Monedas's picture

Is that a stalk of broccoli in your pocket .... or are you just happy to see me ?

Peter Pan's picture

If you honestly believe that 99% of the people are responsible for the mess we are in then the top 1% are truly saviours and we deserve both them and what is happening.

I believe that the top 1% both understand and are driving the mess we are in even though they are better positioned to reverse the downward spiral of the USA.