# Guest Post: The Pareto Economy

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.

## Comment viewing options

Sun, 02/17/2013 - 19:12 | bank guy in Brussels

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

Sun, 02/17/2013 - 19:36 | Kitler

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...)

Sun, 02/17/2013 - 19:39 | CH1

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

The solution is to stop obeying liars and thieves.

Sun, 02/17/2013 - 19:41 | MrX

80% of the weed is consumed by me.

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

Sun, 02/17/2013 - 19:44 | Manthong

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.

Sun, 02/17/2013 - 22:11 | goldfish1

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

Mon, 02/18/2013 - 01:22 | macholatte

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

Mon, 02/18/2013 - 09:40 | qqqqtrader

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

and the other 20% have an IQ of 80

Mon, 02/18/2013 - 10:29 | johnQpublic

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

Mon, 02/18/2013 - 07:38 | Frankie Carbone

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.

Sun, 02/17/2013 - 22:49 | Anusocracy

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.

Sun, 02/17/2013 - 19:15 | Motorhead

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

Sun, 02/17/2013 - 22:59 | Raymond K Hessel

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

Mon, 02/18/2013 - 07:42 | Motorhead

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

Wed, 02/20/2013 - 14:51 | matrix2012

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.

Mon, 02/18/2013 - 09:21 | Taint Boil

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

Sun, 02/17/2013 - 19:17 | dick cheneys ghost

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

Sun, 02/17/2013 - 19:24 | Yen Cross

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

Sun, 02/17/2013 - 19:25 | DoChenRollingBearing

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.

Sun, 02/17/2013 - 21:46 | Matt

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.

Sun, 02/17/2013 - 22:37 | trillion_dollar...

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.

Sun, 02/17/2013 - 22:59 | DoChenRollingBearing

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

Sun, 02/17/2013 - 23:45 | Anusocracy

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

Sun, 02/17/2013 - 19:30 | trendybull459

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/

Sun, 02/17/2013 - 19:39 | Yen Cross

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

Sun, 02/17/2013 - 20:20 | Monedas

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

Sun, 02/17/2013 - 20:37 | Taint Boil

I prefer all caps and in bold - easier to read

Sun, 02/17/2013 - 20:56 | Monedas

80% taint 20% boil ?

Sun, 02/17/2013 - 23:02 | DoChenRollingBearing

20% bearing the other 80%...

Mon, 02/18/2013 - 07:40 | Frankie Carbone

And sentences less than 500 words always helps too!

Sun, 02/17/2013 - 19:38 | Peter Pan

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.

Sun, 02/17/2013 - 19:42 | McMolotov

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

Sun, 02/17/2013 - 20:04 | disabledvet

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

Sun, 02/17/2013 - 19:48 | Shell Game

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!

Mon, 02/18/2013 - 14:11 | Panafrican Funk...

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.

Sun, 02/17/2013 - 19:58 | orangegeek

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!!!

Sun, 02/17/2013 - 19:58 | Rustysilver

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

Sun, 02/17/2013 - 19:59 | Yen Cross

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

Sun, 02/17/2013 - 19:59 | sunnyside

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?

Sun, 02/17/2013 - 20:50 | NoDebt

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.

Sun, 02/17/2013 - 20:52 | itstippy

"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.

Sun, 02/17/2013 - 21:23 | McMolotov

"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.

Sun, 02/17/2013 - 20:01 | buzzsaw99

the crack of doom fixes everything

Sun, 02/17/2013 - 20:04 | Monedas

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

Sun, 02/17/2013 - 20:06 | Monedas

"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

Sun, 02/17/2013 - 20:19 | Smegley Wanxalot

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

Sun, 02/17/2013 - 20:15 | Stuck on Zero

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

Sun, 02/17/2013 - 20:24 | Super Broccoli

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 !

Sun, 02/17/2013 - 20:28 | Monedas

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

Sun, 02/17/2013 - 21:59 | Peter Pan

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.

Wed, 02/20/2013 - 22:56 | MeelionDollerBogus

At least 80% of the fuckers on this planet are so bereft of intellect or life experience or any kind of logical ability they'll gladly demand slavery upon themselves & insist it's better if their neighbors (that's us) enjoy it too.

So ya, they pretty much are the problem. The elite bank robbers of the world only get away with it because the larger populace doesn't use numbers, masses of riots, to attack, jail & execute the fuckers.

Sun, 02/17/2013 - 20:25 | Monedas

20% of dog kibbles is protein .... 80% is filler and stool builder !

Sun, 02/17/2013 - 20:27 | Who is John Galt

20% of the posters on this site account for 80% of the moronic posts.

Mon, 02/18/2013 - 03:38 | mkhs

No, 80% account for the moronic posts; 20% have some value.

Sun, 02/17/2013 - 20:28 | Whatta

so would it be 80% of GS calls cause 20% losses or vice-versa?

Mon, 02/18/2013 - 00:24 | RopeADope

20% of global fraud is derived from 80% of GS revenues.

Sun, 02/17/2013 - 20:28 | Silversinner

having 80% of the sex with 20% of the girls.

having 20% of the sex with 80% fat and ugly girls.

damn booze.

Sun, 02/17/2013 - 20:31 | Monedas

80% of the posters account for 20% of the humour !

Sun, 02/17/2013 - 20:31 | Whatta

Icahn's 20% stake in HLF causes Ackman 80% losses?

Sun, 02/17/2013 - 20:35 | Smegley Wanxalot

80% of the STDs I have came from 20% of da ho's I banged.

Sun, 02/17/2013 - 20:41 | smacker

80% of political elites are a complete waste of space. The other 20% do something useful, for themselves.

Sun, 02/17/2013 - 20:47 | Monedas

Western economies are 20% Capitalist .... 80% Socialist !

Sun, 02/17/2013 - 21:13 | smacker

Exactly so. But we're not supposed to notice, 80% of the time.

Sun, 02/17/2013 - 20:50 | Monedas

20% of the Khmer Rouge killed 80% of Cambodia's literates !

Sun, 02/17/2013 - 20:51 | Monedas

80% of your Lasagne is horsemeat .... 20% is beef !

Sun, 02/17/2013 - 20:58 | Snoopy the Economist

The 80/20 rule is truly powerful. It may sound sad but I try to live my life by the 80/20 rule - everything I do I follow this rule and by addressing 20% of teh biggest issues I find that many of the smaller '80%' issues fix themselves. Ahh the life of an engineer.

Sun, 02/17/2013 - 21:07 | Monedas

If you measure your dick .... starting from your asshole .... 20% is taint .... 80% is dick !

Sun, 02/17/2013 - 21:08 | egoist
Sun, 02/17/2013 - 21:56 | jballz

20% of zerohedge posts account for 80% of my shitty mood.

Sun, 02/17/2013 - 22:50 | socalbeach

From Wikipedia,

"It is a common rule of thumb in business; e.g., "80% of your sales come from 20% of your clients". Mathematically, where something is shared among a sufficiently large set of participants, there must be a number k between 50 and 100 such that "k% is taken by (100 - k)% of the participants". The number k may vary from 50 ... to nearly 100 ... There is nothing special about the number 80% mathematically, but many real systems have k somewhere around this region of intermediate imbalance in distribution."

Sun, 02/17/2013 - 22:30 | smartstrike

If 20% earn 80% of the profits, how is the economy supposed to work? The Pareto principle would suggest that the economy isn't working for 80%?

Sun, 02/17/2013 - 22:37 | Smegley Wanxalot

80% of the time I waste online is wasted on 20% of the porn sites I visit.

80% of owebama is ass, 20% is hole.

Sun, 02/17/2013 - 22:58 | Pareto

I thought the Pareto rule (principle) was simply this: Given any endowment between two or more individuals, Pareto efficiency occurs when there is an opportunity for an exchange such that at least one person is made better off and no one person is made worse off.  It wasn't until neoclassical economists got a hold of this and developed authoritarian government redistribution measures such as the Kaldor/Hicks coercive kind, where a redistribution is said to be Pareto efficient if as a result of government action, the winners could compensate the losers and still leave something left over regardless of whether compensation is actually paid.

Frank Michelman (1967) evaluates the Pareto criterion and the "just compensation" principle in the context of regulatory takings and the takings clause to the 5th Amendment (...nor shall private property be taken for public use without just compensation - Takings Clause, 5th Amendment, US Constitution).  The utilitarian welfare maximization principle (or the Kaldor/Hicks efficiency) uses the Pareto criterion as a crutch, in my opinion, insofar as I doubt Vilfredo ever had the social welfare maximization principle in mind.  Michelman, didn't think so either.

He emphasized, among other things, that demoralization costs are not, nor have ever beem factored into the Pareto principle when applied to social welfare maximization redistribution schemes conjured by government.  Michelman's demoralization costs constitute, "the total value of (1) the dollar value necessary to offset disutilities which acrue to losers and their sympathizers specifically from the realization that no compensation is offered, and (2) the present capitalized dollar value of llost future production (reflecting either impaired incentives, or, social unrest) caused by demoralization of uncompensated losers, their sympathizers, and other observers disturbed by the thought that they themselves may be subjetced to similar treatment on some other occasion" (p. 1214).

Never heard of the 80-20 rule in the context of Pareto efficiency.

Sun, 02/17/2013 - 23:42 | faustian bargain

"Never heard of the 80-20 rule in the context of Pareto efficiency."

Er, what? Never heard of it?

Mon, 02/18/2013 - 00:25 | Pareto

Its true.  I hardly understand this to be his greatest contribution, but, evidently it is.  In economics, the 80-20 principle was never the focus of Pareto's work.  Welfare economics focused strictly on the maximization principle.  Admitedly, I know little about the 80-20 rule.

Mon, 02/18/2013 - 00:46 | Monedas

Please try to stay on topic .... 20% of single guys .... get 80% of the available ass !

Sun, 02/17/2013 - 23:45 | adr

Manufacturing and overhead usually takes up around 20% of the MSRP of a decent quality product. For a time 40% profit went to the manufacturing distributor and 40% went to the retail store. Equal distribution of profit. This then went to keystone pricing, 50% margin to the retailer, 30% to distributor. Next came the push to 60% retail margin. The mega retailers are now starting to push for 80% margin. Once that line is crossed it becomes impossible to produce any quality product and make a profit as a manufacturing distributor. If cost is 20% and you must sell at 80% margin, there is no profit. So the manfacturing distributor is destroyed.

In fact the line has been crossed already, only outsourcing and reducing quality have allowed profit to be generated out of the ever shrinking margin of a manufacturing distributor.

Big retail has started to go direct to overseas manufacturers and purchase the rights to brand names. Dick's Sporting Goods purchasing the rights for Reebok and Adidas Baseball. The name is worth 10%, manufacturing and overhead add 20%. This leaves Dick's with 70% margin. To get to 80% they reduce quality 10%. This leaves 10% for name and 10% for the actual product. \$10 retail produced for \$1.

Same goes for JC Penney. The already reduced quality by 10%, but sales did not follow. In order to increase sales, they cut retail prices. They eliminated the brand and brought out JC Penney brand clothes saving the 10% brand fee. We'll see if it works. Sure you now pay \$18 instead of \$20, but it still only cost \$2 to make the shirt. Some people think the label with a brand is worth the extra \$2.

It really is all bullshit. Wall Street makes sure of that.

Mon, 02/18/2013 - 01:10 | HeavydutyMexica...

80% enter through the wide door, 20% enter through the narrow door.

Mon, 02/18/2013 - 07:16 | mellons

Disappointing to read such nonsense in zh

A ratio is meaningless if it can be applied arbitrarily to any relationship without any factual basis.

Wed, 02/20/2013 - 22:48 | MeelionDollerBogus

the ratio IS the factual basis, just like with Fibonacci. One set of data is a set of facts, another set of facts contains the mathematical relationships that exist in the data. None of it is conjecture, opinion or deniable.

If you want to show it's inapplicable in certain cases then pick a case and make your case. Where it's held as applicable people have picked a case & made a case (successfully defended).

Mon, 02/18/2013 - 08:15 | Cloud9.5

So 20% are the critical mass needed for a change?

Mon, 02/18/2013 - 08:39 | kralizec

I keep reading about doom, when do I get to see it?  Frankly, I am surprised we made it this far. . .

Mon, 02/18/2013 - 09:09 | TrumpXVI

I believe I've got another example.

With women, 20% of their behavior is the product of their individual personality, and 80% of their behavior is due simply to the fact that they are women!

Mon, 02/18/2013 - 13:56 | whoknoz