Moontower #37

Friends,

Imagine. You’re a zygote hanging out in the fancy airport lounge of the cosmic ether. Chatting with other unborns while sipping a mimosa and charging your phone. Meanwhile on Earth, a couple bails early from a holiday party and Lyfts it home. The couple will soon be asleep but not before the ancient power of wine and nature take its course.

The loudspeaker in the cosmic airport lounge summons you. Next thing you know, you’re en route to sit in a uterine waiting room until Labor day.

Who Will I Be Born To?

Let’s say you start flipping a coin on the flight. How many heads in a row you flip determines whose house you go to. No heads at all? Ouch. Your soon-to-be-mother is struggling to keep a job while her baby daddy stands before a judge for domestic violence.

Flip a single head and you arrive at the median net worth household. You got two parents and statistically speaking .5 siblings.

Flip 3 in a row and you’ll get some overachieving parents who are going to spend the next 5 years wondering if they should ‘redshirt’ in kindergarten since your birthday is right on the cut-off and if your the oldest kid in the class you’ll be better at sports and blah, blah, blah, blah…You’ll probably be in the safest car seat and your parents the life of the party I’m sure.

Now, what about 11 heads in a row? Jackpot. You are being dropped into a Calabasas mansion to an ambitious family that knows how to wring clicks from the genetic advantages securely stored in your carry-on. In an era where anyone can get Warhol’s “15 minutes” but not a minute more, this family knows how to get their 15 years (and counting).

This table approximates the household a zygote headed for America can fall into. (I cobbled it together from 2016 DQYDJ data).

Enter Kylie Jenner

After selling a stake in her cosmetics brand she is now worth $1.2 billion. Here’s context:

First off, let’s just get one indisputable fact out of the way: Team Kylie Jenner has built a remarkable business. It posted revenues of $200m last year, and is on track for Ebitda margins of 25 per cent this, all while growing 40 per cent. For reference that’s more Ebitda than Uber, Lyft and Peloton made in the last quarter. Combined. (Link)

Then this guy:

The internet has been arguing over whether she is “self-made”. Just check out the comments.

People can’t wait to discount the success of people who “start on third base”. People like to drink Haterade. That’s old news. But it does bring up an interesting question. How likely or unlikely was such an outcome based on where she came from? After all, her half-brother Rob shared many of the same advantages.

What would be the equivalent level of success for somebody who started in a regular household? Well, let’s see. We can use the table to see how many heads in a row it would take Kylie to become a billionaire from her roots. Her silver spoon roots place her somewhere between decamillionaire and centimillionaire. From there, it’s about 7 heads in a row to billionaire. Translating that to a person born into the median net worth home, that’s the equivalent of Mary Smith rising to become the richest person at their HS if not their whole school. A 99.9 percenter.

Using that logic, you can still see just how unlikely it was to pull off what she did. You can lessen it since it wasn’t impossible from the get-go but there’s lots of things that impress us even if they aren’t impossible. Throw in the fact that regression to the mean shows most rich kids remain outshined by their illustrious parents. Meanwhile, Kylie blew them out of the water (financially speaking).

Dissonance

You’re skeptical. “Wait a minute, Kris, you can’t use the raw odds of being born into a certain household to estimate the probability of moving higher through the ranks? When Kylie gets her last name she also gets a weighted coin.”

Congratulations. You have just discovered a major flaw in the income equality conversation dominating the nation. In this week’s Money Angle we’ll see why.

The Money Angle

Blind luck matches your unborn spirit to a physical baby body on Earth. The spirit didn’t audition for the part. Where you arrive? To whom? In what century? Blind, dumb luck.  But the second the baby opens her eyes her conditions and her genes interact. A unique trajectory unfolds.

Repeat this process billions of times across geography and history. Interject randomness, a magical insight or a stray bullet. Watch as outcomes diverge just as a narrow river flows down a hill, widens at the mouth, then spreads into a vast ocean.

The combinations are infinite and we can’t help but wonder what variables along the way cause which outcomes. Consider the life of an attractive woman. I’m ready to non-ironically play the violin for exceptionally pretty girls. Why? Because I can’t imagine how they must navigate all the distorting signals they receive, an excessive quota of creepers they’re going to attract (in addition to desirable mates), the baggage they might have incurred in the process, and the feedback loops that sweep them up. It’s easy to see how arrows of causality rarely point in one direction. Every blessing rides with its own curse.

How does this relate to income inequality? 

In order to study how people arrive at different outcomes you must follow the same people around and only then do you have a chance to disentangle the interaction of their qualities from their conditions. You must track the water as it travels from peak to basin. If you just sample the water in the starting and ending locations you have no chance of uncovering whys and hows.

The discourse on income inequality makes exactly this mistake. Everyone is familiar with a graph that looks something like this:

If you Google image search “income inequality” you will be bombarded with charts like this showing that the rich’s share of income has increased relative to the poor and median. While it’s true that the bucket of people considered “rich” now earn even more than the bucket called “poor” over time, these studies are all based on snapshots. And they make great kindling for outrage, attention, and political thrust. They sell like steroids at the Jersey Shore.

But it also masks the good news. Regrettably, good news doesn’t have a natural buyer.

Like the Kylie Jenner problem, that chart tells us absolutely nothing about one’s chance of climbing or falling through the ranks. That is the question we really care about. Russ Roberts writes:

What the snapshots show is that the rich today are richer than the rich of yesterday. If rich people are the same people as yesterday, then one’s class determines one’s fate. But if they are not the same people, the snapshots tell you that the dispersion of income has increased. That may or may not bother you, but it doesn’t necessarily mean that there is a distinct group called “the rich” who are capturing all the gains while the rest of us tread water.

A Much Rosier View

In his outstanding essay (link), which I’d go far as to call a PSA, Roberts shows the most dramatic claims by the pessimists that no one is making progress other than the rich are wrong.

1) Distortions in the snapshot methods conspire to make inequality look much worse than it really is.

You can’t use two snapshots to conclude that only the rich have made progress. It’s possible that everyone from the earlier snapshot has actually gotten richer and then been replaced by different people whose incomes will also rise. The people in the snapshots are not the same people. 

Immigration, divorce, and marriage rates all distort measure of progress. Roberts creates this easy-to-follow video showing how snapshot math can make it appear that the poor are doing worse even when everyone’s income doubles!

In this diagram captured from the video he creates a hypothetical to demonstrate how divorce rates impact snapshots.

Imagine 5 quintiles with 2 families in each bucket. Every person earns the same amount. 30 years later we take another snapshot and every individual’s income doubles but half the families divorce resulting in 5 more households. Now when you look at the quintiles it appears the top 2 quintiles benefitted at the expense of everyone else, yet in this example, every person in society is benefitting equally from the stronger economy.

Immigration and marriage rates will reveal similar effects.

2) Longitudinal studies > snapshot studies

Roberts emphasizes the biggest problem with the pessimistic studies is that they rarely follow the same people to see how they do over time.

The data crunchers at DQYDJ, a leading site for income studies, make similar warning when viewing data that is not longitudinal:

You can not draw any conclusions about the performance of individual households from this data. Households in certain income brackets move up or down the income spectrum, but the data as presented doesn’t give any history or hint of movement. The only fair way to draw conclusions about the performance of last year’s households is with repeat surveys given to the same subjects.
3) The American dream is alive and well

Roberts reveals encouraging conclusions when you look at the results of longitudinal studies. Many are summarized in this video.

The pessimistic story based on comparing snapshots of the economy at two different points in time misses the underlying dynamism of the American economy… When you follow the same people over time, the largest gains over time often go to the poorest workers; the richest workers often make no progress.

4) What it actually looks like when “the ladder has been pulled up”

Nassim Taleb observes social mobility in the US vs Europe:

Static inequality is a snapshot view of inequality; it does not reflect what will happen to you in the course of your life

Consider that about ten percent of Americans will spend at least a year in the top one percent and more than half of all Americans will spend a year in the top ten percent. This is visibly not the same for the more static –but nominally more equal –Europe. For instance, only ten percent of the wealthiest five hundred American people or dynasties were so thirty years ago; more than sixty percent of those on the French list were heirs and a third of the richest Europeans were the richest centuries ago. In Florence, it was just revealed that things are really even worse: the same handful of families have kept the wealth for five centuries.

You do not create dynamic equality just by raising the level of those at the bottom, but rather by making the rich rotate –or by forcing people to incur the possibility of creating an opening.

The way to make society more equal is by forcing (through skin in the game) the rich to be subjected to the risk of exiting from the one percent

Or, more mathematically

Dynamic equality assumes Markov chains with no absorbing states

Our condition here is stronger than mere income mobility. Mobility means that someone can become rich. The no absorbing barrier condition means that someone who is rich should never be certain to stay rich.
Pulling from a NYTimes op-ed, this tweet maintains that economic rotation remains alive and well in the US.

Final Takeaway

As you get bombarded this election season with discussion of income inequality, remember, the snapshot view you are being fed is:

a) politically useful

and

b) doesn’t answer the question you care about: what are the prospects for me and my loved ones?

That the rich today are richer than the rich of yesterday is a very different finding than that the rich are getting all the gains. Too many economists have treated these as identical. The snapshot approach does not capture the impact of economic growth on people’s material well-being or provide evidence that the rich or the poor are static categories no one ever escapes. [While none] of these studies is decisive, [what they] show is that the economic growth of the last 30–40 years has been shared much more widely than is generally found in the cross-section studies that compare snapshots at two different times, following quintiles rather than people.

Extra credit question I have for the finance-minded

Are low real interest rates actually progressive by flattening the compounding effect of wealth. Asked differently: do low rates of return in markets make being rich less of an absorbing barrier?

Climb Higher